Final Report on NPL

8/7/2019 Final Report on NPL

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Table of Contents

1 Topic ................................................................................................................................... 3

Identify The Linkages Between Monetary Policy And Nonperforming Loans. .............................. 3

2 Executive Summary (Abstract) ............................................................................................ 3

3 Introduction:- ....................................................................................................................... 4

3.1 Monetary Policy:- ......................................................................................................... 4

3.2 Overview:- .................................................................................................................... 4

3.3 Theory .......................................................................................................................... 5

3.4 HistoryofMonetary Policy: .......................................................................................... 6

3.5 Trends in Central Banking: ............................................................................................ 7

4 Monetary PolicyTools ......................................................................................................... 9

4.1 Monetary base .............................................................................................................. 9

4.2 Reserve requirements .................................................................................................... 9

4.3 Discount window lending ............................................................................................. 9

4.4 Interestrates ................................................................................................................. 9

4.5 Currency board ........................................................................................................... 10

5 Types ofMonetary Policy .................................................................................................. 10

5.1 Reserve Requirement .................................................................................................. 11

5.2 Market Operation ........................................................................................................ 11

5.3 Federal Funds Rate ..................................................................................................... 11

5.4 Discount Rate: ............................................................................................................ 11

6 Loan: ................................................................................................................................. 11

6.1 Characteristic OF Loan ............................................................................................... 12

6.2 Common Types Ofloans ............................................................................................ 12

7 Research Methodology:- .................................................................................................... 13

8 Scope:- .............................................................................................................................. 13

9 Type ofResearch: .............................................................................................................. 13

9.1 Data Collection Method:- ............................................................................................ 14

9.2 Variables:- .................................................................................................................. 14

9.3 Hypothesis: ................................................................................................................. 14

10 Literature Review: .......................................................................................................... 14

11 YEAR WISE NON PERFORMING LOANS (NPLS) FROM FY 2006-07 TO FY 2008-09: 16


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11.1 YearWise Non Performing Loans (NPLs) 2006-07: ................................................ 16

11.2 TrendofNon Performing Loans (NPLs) 2007-08: ................................................... 17

11.3 TrendofNon Performing Loans (NPLs) (2008-09): ................................................ 17

12 Total Nonperforming loans in the Economy: .................................................................. 17

12.1 HistoricalTrendofNonperforming Loans: .............................................................. 18

13 Loan Pricing Strategies AndTable OF KIBOR And NPLS OverThe Years: .................. 19

14 Factors Affecting the KIBOR: ........................................................................................ 23

14.1 Inflation: ................................................................................................................. 23

14.2 Foreign exchange rate ............................................................................................. 24

14.3 Trade Deficit ........................................................................................................... 25

14.4 Political Uncertainty: ............................................................................................... 26

15 Correlation between KIBORand Non performing Loans:- ............................................. 27

16 Hypothesis Steps: ........................................................................................................... 2817 Findings: ........................................................................................................................ 30

18 References:- ................................................................................................................... 31


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1TopicIdentify The Linkages Between Monetary Policy And Nonperforming Loans.

2Executive Summary (Abstract)The regulation of the money supply and interest rates by a central bank, such as the State Bank in the

Pakistan, in order to control inflation and stabilize currency. Monetary policy is one the two ways the

government can impact the economy. By impacting the effective cost of money, the Central bank canaffect the amount of money that is spent by consumers and businesses. There is also a Policy rate that playsa vital role in achieving the objective and goals of economy. It will be on increasing or Discount rate, reducing the

inflation rate, made the policy decisions on Nonperforming loans and made the requirement of CRR (Cash Reserve

Requirement) and SLR (Statutory Liquidity Requirement) of the banks ETC. The central bank influences interest

rates by expanding or contracting the monetary base, which consists of currency in circulation and banks' reserves

on deposit at the central bank. The primary way that the central bank can affect the monetary base is by open

market operations or sales and purchases of second hand government debt, or by changing the reserve

requirements. If the central bank wishes to lower interest rates, it purchases government debt, thereby increasing

the amount of cash in circulation or crediting banks' reserve accounts.

The tools of monetary policy are as follows;

1) Monetary base

2) Reserve Requirements

3) Discount window lending

4) Interest Rate

5) Currency Board

Nonperforming loan is the important factor to measure the performance of the economy. So one important

part of monetary policy is that it also measures the nonperforming loans and tried to control these

nonperforming loans by making policy rate or by setting interest rate etc. In 2010 total NPLs of SME sector

stood at Rs 82.7 billion, NPLs of microfinance banks went down from Rs 224 million to Rs 214 million,

and non-performing loans in agriculture financing stood at Rs 33.9 billion at end March 2010. Fromhistorical trend such as from 2000 to 2009 the Nonperforming loans were increasing this was only due to

KIBOR because the KIBOR was also increasing i.e. from 1.35 % to 12.88% from 2003 to 2009. So there is a

correlation between monetary policy and Nonperforming loans. There are many factors that are affecting the

KIBOR such as inflation, foreign exchange rate, trade deficit, Political Uncertainty. The variables of my research


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are KIBOR and Nonperforming loans and I had found the correlation between these two variables through Test

of Correlation.

3 Introduction:-3.1 Monetary Policy:-

Monetary policy is the process by which the central bank or monetary authority of a country controls the supply of

money, often targeting a rate of interest. Monetary policy is usually used to attain a set of objectives orientedtowards the growth and stability of the economy. These goals usually include stable prices and low unemployment.

Monetary theory provides insight into how to craft optimal monetary policy.

Monetary policy is referred to as either being an expansionary policy, or a contractionary policy, where an

expansionary policy increases the total supply of money in the economy rapidly, and a contractionary policy

decreases the total money supply or increases it only slowly. Expansionary policy is traditionally used to combat

unemployment in a recession by lowering interest rates, while contractionary policy involves raising interest rates to

combat inflation. Monetary policy is contrasted with fiscal policy, which refers to government borrowing, spending

and taxation.

3.2 Overview:-Monetary policy rests on the relationship between the rates of interest in an economy, that is the price at which

money can be borrowed, and the total supply of money. Monetary policy uses a variety of tools to control one or

both of these, to influence outcomes like economic growth, inflation, exchange rates with other currencies and

unemployment. Where currency is under a monopoly of issuance, or where there is a regulated system of issuing

currency through banks which are tied to a central bank, the monetary authority has the ability to alter the money

supply and thus influence the interest rate (to achieve policy goals). The beginning of monetary policy as such

comes from the late 19th century, where it was used to maintain the gold standard.

A policy is referred to as contractionary if it reduces the size of the money supply or increases it only slowly, or if it

raises the interest rate. An expansionary policy increases the size of the money supply more rapidly, or decreasesthe interest rate. Furthermore, monetary policies are described as follows: accommodative, if the interest rate set

by the central monetary authority is intended to create economic growth; neutral, if it is intended neither to create

growth nor combat inflation; or tight if intended to reduce inflation.

There are several monetary policy tools available to achieve these ends: increasing interest rates by fiat; reducing

the monetary base; and increasing reserve requirements. All have the effect of contracting the money supply; and,

if reversed, expand the money supply. Since the 1970s, monetary policy has generally been formed separately from


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fiscal policy. Even prior to the 1970s, the Bretton Woods system still ensured that most nations would form the two

policies separately.

Within almost all modern nations, special institutions (such as the Bank of England, the European Central Bank,

Reserve Bank of India, the Federal Reserve System in the United States, the Bank of Japan, the Bank of Canada or

the Reserve Bank of Australia) exist which have the task of executing the monetary policy and often independently

of the executive. In general, these institutions are called central banks and often have other responsibilities such as

supervising the smooth operation of the financial system.

The primary tool of monetary policy is open market operations. This entails managing the quantity of money in

circulation through the buying and selling of various financial instruments, such as treasury bills, company bonds, or

foreign currencies. All of these purchases or sales result in more or less base currency entering or leaving market

circulation.

Usually, the short term goal of open market operations is to achieve a specific short term interest rate target. In

other instances, monetary policy might instead entail the targeting of a specific exchange rate relative to some

foreign currency or else relative to gold. For example, in the case of the USA the Federal Reserve targets the federal

funds rate, the rate at which member banks lend to one another overnight; however, the monetary policy of Chinais to target the exchange rate between the Chinese renminbi and a basket of foreign currencies.

The other primary means of conducting monetary policy include: (i) Discount window lending (lender of last resort);

(ii) Fractional deposit lending (changes in the reserve requirement); (iii) Moral suasion (cajoling certain market

players to achieve specified outcomes); (iv) "Open mouth operations" (talking monetary policy with the market).

3.3 TheoryMonetary policy is the process by which the government, central bank, or monetary authority of a country

controls

I. the supply of money,

II. availability of money, and

III. Cost of money or rate of interest to attain a set of objectives oriented towards the growth and stability of

the economy. Monetary theory provides insight into how to craft optimal monetary policy.

IV. Policy Rate

If policymakers believe that private agents anticipate low inflation, they have an incentive to adopt an

expansionist monetary policy (where the marginal benefit of increasing economic output outweighs the marginal

cost of inflation); however, assuming private agents have rational expectations, they know that policymakers have

this incentive. Hence, private agents know that if they anticipate low inflation, an expansionist policy will be

adopted that causes a rise in inflation. Consequently, (unless policymakers can make their announcement of lowinflation credible), private agents expect high inflation. This anticipation is fulfilled through adaptive expectation

(wage-setting behavior); so, there is higher inflation (without the benefit of increased output). Hence, unless

credible announcements can be made, expansionary monetary policy will fail.

There is also a Policy rate that plays a vital role in achieving the objective and goals of economy. The policy rate

was decided by Regulator or Central bank of the Country. Nearly all central banks now announce publicly their

policy actions; most provide detailed information about their policy meetings in the form of minutes, press


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briefings, or even transcripts; many make their policy intentions clear by announcing inflation targets or other

objectives; and some release their economic projections. The current cutting edge of the movement towards

greater transparency is the issue of whether or not central banks should provide regular forecasts of their own

policy rates. Now in Pakistan the State Bank of Pakistan set the Policy rate in achieving the economic objectives by

setting some milestones. It will be on increasing or Discount rate, reducing the inflation rate, made the policy

decisions on Nonperforming loans and made the requirement of CRR (Cash Reserve Requirement) and SLR

(Statutory Liquidity Requirement) of the banks ETC.

3.4 History of Monetary Policy:Monetary policy is primarily associated with interest rate and credit. For many centuries there were only two

forms of monetary policy: (i) Decisions about coinage; (ii) Decisions to print paper money to create credit. Interest

rates, while now thought of as part of monetary authority, were not generally coordinated with the other forms of

monetary policy during this time. Monetary policy was seen as an executive decision, and was generally in the

hands of the authority with seignior age, or the power to coin. With the advent of larger trading networks camethe ability to set the price between gold and silver, and the price of the local currency to foreign currencies. This

official price could be enforced by law, even if it varied from the market price.

With the creation of the Bank of England in 1694, which acquired the responsibility to print notes and back them

with gold, the idea of monetary policy as independent of executive action began to be established. The goal of

monetary policy was to maintain the value of the coinage, print notes which would trade at par to specie, and

prevent coins from leaving circulation. The establishment of central banks by industrializing nations was

associated then with the desire to maintain the nation's peg to the gold standard, and to trade in a narrow band

with other gold-backed currencies. To accomplish this end, central banks as part of the gold standard began

setting the interest rates that they charged, both their own borrowers, and other banks that required liquidity.

The maintenance of a gold standard required almost monthly adjustments of interest rates.

During the 1870-1920 periods, the industrialized nations set up central banking systems, with one of the last being

the Federal Reserve in 1913.By this point the role of the central bank as the "lender of last resort" was

understood. It was also increasingly understood that interest rates had an effect on the entire economy, in no

small part because of the marginal revolution in economics, which demonstrated how people would change a

decision based on a change in the economic trade-offs.

Monetarist macroeconomists have sometimes advocated simply increasing the monetary supply at a low, constant

rate, as the best way of maintaining low inflation and stable output growth. However, when U.S. Federal Reserve

Chairman Paul Volker tried this policy, starting in October 1979, it was found to be impractical, because of the

highly unstable relationship between monetary aggregates and other macroeconomic variables. Even Milton

Friedman acknowledged that money supply targeting was less successful than he had hoped, in an interview withthe Financial Times on June 7, 2003.Therefore, monetary decisions today take into account a wider range of

factors, such as:

y short term interest rates;

y long term interest rates;

y velocity of money through the economy;

y exchange rates;


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y credit quality;

y bonds and equities (corporate ownership and debt);

y government versus private sector spending/savings;

y international capital flows of money on large scales;

y Financial derivatives such as options, swaps, futures contracts, etc.

A small but vocal group of people advocate for a return to the gold standard (the elimination of the dollar's fiat

currency status and even of the Federal Reserve Bank). Their argument is basically that monetary policy is fraught

with risk and these risks will result in drastic harm to the populace should monetary policy fail. Other sees another

problem with our current monetary policy. The problem for them is not that our money has nothing physical to

define its value, but that fractional reserve lending of that money as a debt to the recipient, rather than a credit,

causes all but a small proportion of society (including all governments) to be perpetually in debt.

In fact, many economists disagree with returning to a gold standard. They argue that doing so would drastically

limit the money supply, and throw away 100 years of advancement in monetary policy. The sometimes complex

financial transactions that make big business (especially international business) easier and safer would be much

more difficult if not impossible. Moreover, shifting risk to different people/companies that specialize in monitoring

and using risk can turn any financial risk into a known dollar amount and therefore make business predictable andmore profitable for everyone involved.

Non-Performing Loans (NPLs) reduces the liquidity of banks, credit expansion, it slows down the growth of the realsector with direct consequences on the performance of banks, the firm which is in default and the economy as awhole. Monetary policy plays a vital in analyzing the performance of bank and economy as a whole. There is acorrelation between monetary policy and Non-performing loans because in monetary policy the discount rate is avariable which create a fluctuation in the spread of banks. If discount rate increases the spread rate decreases orvice versa.

3.5 Trends in Central Banking:The central bank influences interest rates by expanding or contracting the monetary base, which consists of

currency in circulation and banks' reserves on deposit at the central bank. The primary way that the central bank

can affect the monetary base is by open market operations or sales and purchases of second hand government

debt, or by changing the reserve requirements. If the central bank wishes to lower interest rates, it purchases

government debt, thereby increasing the amount of cash in circulation or crediting banks' reserve accounts.

Alternatively, it can lower the interest rate on discounts or overdrafts (loans to banks secured by suitable

collateral, specified by the central bank). If the interest rate on such transactions is sufficiently low, commercial

banks can borrow from the central bank to meet reserve requirements and use the additional liquidity to expand

their balance sheets, increasing the credit available to the economy. Lowering reserve requirements has a similar

effect, freeing up funds for banks to increase loans or buy other profitable assets.

A central bank can only operate a truly independent monetary policy when the exchange rate is floating. If theexchange rate is pegged or managed in any way, the central bank will have to purchase or sell foreign exchange.

These transactions in foreign exchange will have an effect on the monetary base analogous to open market

purchases and sales of government debt; if the central bank buys foreign exchange, the monetary base expands,

and vice versa. But even in the case of a pure floating exchange rate, central banks and monetary authorities can

at best "lean against the wind" in a world where capital is mobile.


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Accordingly, the management of the exchange rate will influence domestic monetary conditions. To maintain its

monetary policy target, the central bank will have to sterilize or offset its foreign exchange operations. For

example, if a central bank buys foreign exchange (to counteract appreciation of the exchange rate), base money

will increase. Therefore, to sterilize that increase, the central bank must also sell government debt to contract the

monetary base by an equal amount. It follows that turbulent activity in foreign exchange markets can cause a

central bank to lose control of domestic monetary policy when it is also managing the exchange rate.

In the 1980s, many economists began to believe that making a nation's central bank independent of the rest of

executive government is the best way to ensure an optimal monetary policy, and those central banks which did

not have independence began to gain it. This is to avoid overt manipulation of the tools of monetary policies to

effect political goals, such as re-electing the current government. Independence typically means that the members

of the committee which conducts monetary policy have long, fixed terms. Obviously, this is a somewhat limited

independence.

In the 1990s, central banks began adopting formal, public inflation targets with the goal of making the outcomes,

if not the process, of monetary policy more transparent. In other words, a central bank may have an inflation

target of 2% for a given year, and if inflation turns out to be 5%, then the central bank will typically have to submit

an explanation.

The Bank of England exemplifies both these trends. It became independent of government through the Bank of

England Act 1998 and adopted an inflation target of 2.5% RPI (now 2% of CPI).

The debate rages on about whether monetary policy can smooth business cycles or not. A central conjecture of

Keynesian economics is that the central bank can stimulate aggregate demand in the short run, because a

significant number of prices in the economy are fixed in the short run and firms will produce as many goods and

services as are demanded (in the long run, however, money is neutral, as in the neoclassical model).

In Pakistan there is always a trend in the Volatility of discount rate. Due to this the Capital market and financial

markets are affected. If we talk about the recent announcement of the State Bank once again increased the policyinterest rate by 50 basis points, because of fears of higher government borrowing and inflation and lower

economic growth and revenue during the current fiscal year.The rate had been increased by 0.5 percentin the lastmonetarypolicyforAugustand September. The new rate will be effective fromThursday.The statement saidtherecentcatastrophicfloods had serious implications formacroeconomic stabilityand growthprospects. The floods

had notonly effecton increasing the inflation butthere will be alsoa big threatof increasing the Nonperformingloans because mostofthe peoples hadpurchase cars through banks in the urban areas soit was totallydamagedinthe floods, mostofthe farmers hadfinancedtheirlands offarming through banks so now due tothe floodit was not

onlyaffectthe lands offarmers butalsoclose the doors ofearnings forfarmers. Now allthese scenarios willresult

in increasing the Nonperforming loans.

Now the State bankalsoincreasedthe discountrate sothe consumers who were little affected byfloods and which

affecton the income ofconsumers couldalso result in increasing Nonperforming loans because the interest washigh from the previous one. So there willingness topay woulddecrease and interest rate is high so this coulda

create of chances of default by consumer. Highlyprovisional estimates suggest that economic growth forFY11 couldcome down to 2.5 percentfroman earliertargetof4.5 percent, the SBP said.

It saidthere were signs inflation wouldincrease further, accompanied byadropin economic growth, boththe trade balance andfiscalaccounts would be understress andthe banking systemmight witness pressure


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because ofan increase in non-performing loans of the private sectorand borrowings of the government,unless acomprehensive andcoordinatedresponse was developedtomeetthe challenges.

4 Monetary Policy Tools4.1 Monetary base

Monetary policy can be implemented by changing the size of the monetary base. This directly changes the total

amount of money circulating in the economy. A central bank can use open market operations to change the

monetary base. The central bank would buy/sell bonds in exchange for hard currency. When the central bank

disburses/collects this hard currency payment, it alters the amount of currency in the economy, thus altering the

monetary base.

4.2 Reserve requirementsThe monetary authority exerts regulatory control over banks. Monetary policy can be implemented by changing theproportion of total assets that banks must hold in reserve with the central bank. Banks only maintain a small portion

of their assets as cash available for immediate withdrawal; the rest is invested in illiquid assets like mortgages and

loans. By changing the proportion of total assets to be held as liquid cash, the Federal Reserve changes the availability

of loan able funds. This acts as a change in the money supply. Central banks typically do not change the reserve

requirements often because it creates very volatile changes in the money supply due to the lending multiplier.

4.3 Discount window lendingMany central banks or finance ministries have the authority to lend funds to financial institutions within their

country. By calling in existing loans or extending new loans, the monetary authority can directly change the size of

the money supply.

4.4 Interest rates


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The contraction of the monetary supply can be achieved indirectly by increasing the nominal interest rates.

Monetary authorities in different nations have differing levels of control of economy-wide interest rates. In the

United States, the Federal Reserve can set the discount rate, as well as achieve the desired Federal funds rate by

open market operations. This rate has significant effect on other market interest rates, but there is no perfect

relationship. In the United States open market operations are a relatively small part of the total volume in the bond

market. One cannot set independent targets for both the monetary base and the interest rate because they are both

modified by a single tool open market operations; one must choose which one to control. In other nations, the

monetary authority may be able to mandate specific interest rates on loans, savings accounts or other financial

assets. By raising the interest rate(s) under its control, a monetary authority can contract the money supply, because

higher interest rates encourage savings and discourage borrowing. Both of these effects reduce the size of the

money supply.

4.5 Currency boardA currency board is a monetary arrangement that pegs the monetary base of one country to another, the anchor

nation. As such, it essentially operates as a hard fixed exchange rate, whereby local currency in circulation is backed

by foreign currency from the anchor nation at a fixed rate. Thus, to grow the local monetary base an equivalentamount of foreign currency must be held in reserves with the currency board. This limits the possibility for the local

monetary authority to inflate or pursue other objectives. The principal rationales behind a currency board are three-

fold:

1. To import monetary credibility of the anchor nation;

2. To maintain a fixed exchange rate with the anchor nation;

3. To establish credibility with the exchange rate (the currency board arrangement is the

hardest form of fixed exchange rates outside of dollarization).

In theory, it is possible that a country may peg the local currency to more than one foreign currency; although, in

practice this has never happened (and it would be a more complicated to run than a simple single-currency currency

board). A gold standard is a special case of a currency board where the value of the national currency is linked to the

value of gold instead of a foreign currency.

The currency board in question will no longer issue fiat money but instead will only issue a set number of units of

local currency for each unit of foreign currency it has in its vault. The surplus on the balance of payments of that

country is reflected by higher deposits local banks hold at the central bank as well as (initially) higher deposits of the

(net) exporting firms at their local banks. The growth of the domestic money supply can now be coupled to the

additional deposits of the banks at the central bank that equals additional hard foreign exchange reserves in the

hands of the central bank. The virtue of this system is that questions of currency stability no longer apply. The

drawbacks are that the country no longer has the ability to set monetary policy according to other domestic

considerations, and that the fixed exchange rate will, to a large extent, also fix a country's terms of trade,

irrespective of economic differences between it and its trading partners.

Currency boards have advantages for small, open economies that would find independent monetary policy difficult to

sustain. They can also form a credible commitment to low inflation.

5 Types of Monetary Policy


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Monetary policy affects a nation's monetary supply and the direction of its economy. Central banks, such as the Bank

of Canada, the Bank of Japan and the U.S. Federal Reserve, are responsible for enacting monetary policy. Central

bankers have different types of policy actions at their disposal, and they can use these in an expansionary or

contractionary manner, depending on economic conditions. The four main types of monetary policies are bank

reserve requirements, open market operations, the federal funds rate and the discount rate.

5.1 Reserve RequirementThrough reserve requirements, the central bank requires banks and other depository institutions to hold a certain

amount of funds in reserve to meet outflows of money, such as customer withdrawals. Banks may hold these

reserves as cash in their vaults, as deposits with the central bank or as a combination of the two. When a central

bank's policy-making body, such as the Federal Reserve Open Market Committee, wants to expand the money supply,

it can lower reserve requirements. This puts more money into circulation by freeing banks to engage in more lending.

Raising reserve requirements, in contrast, lowers the money supply by requiring banks to hold more money in

reserve, making less available for lending.

5.2 Market OperationAn important type of monetary policy tool, open market operations involve the purchase and sale of government

securities on the open market by central banks. In United States the Federal Reserve Bank of New York conducts

open market operations. When the central bank wants to expand the money supply, it purchases securities from a

bank, increasing that bank's reserves as payment. This gives that bank more reserves than it want, freeing it to lend

the funds. To reduce the money supply, the Federal Reserve sells government securities to banks and receives

reserves as payment, which lowers those banks' supply of reserves.

5.3 Federal Funds RateThe federal funds rate is an interest rate that banks charge each other for short-term loans. Federal Reserve policy

makers adjust this interest rate in response to economic conditions. When inflationary pressures appear in the

economy, the Federal Reserve often increases the federal funds rate, making it more expensive to borrow reserves

and thus reducing the money supply. Lowering the federal funds rate expands the money supply.

5.4 Discount Rate:The discount rate is the interest rate that the Federal Reserve and other countries' central banking authorities

charge banks and other depository institutions for borrowing reserves. The discount rate is typically higher than the

federal funds rate, to discourage banks from turning to this lending source before other alternatives.

6 Loan:A loan is the purchase of the present use of money with the promise to repay the amount in the future according to

a pre-arranged schedule and at a specified rate of interest. Loan contracts formally spell out the terms and

obligations between the lender and borrower. Loans are by far the most common type of debt financing used by

small businesses. Loans can be classified as long-term (with a maturity longer than one year), short-term (with a


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maturity shorter than two years), or a credit line (for more immediate borrowing needs). They can be endorsed by

co-signers, guaranteed by the government, or secured by collateralsuch as real estate, accounts receivable,

inventory, savings, life insurance, stocks and bonds, or the item purchased with the loan. The interest rate charged

on the borrowed funds reflects the level of risk that the lender undertakes by providing the money. For example, a

lender might charge a startup company a higher interest rate than it would a company that had shown a profit for

several years.

6.1 Characteristic OF LoanLoans have the following distinguishing characteristics:

1.Time to maturity. Time to maturity describes the length of the loan contract. Loans are classified according

to their maturity into short-term debt, intermediate-term debt, and long-term debt. Revolving credit andperpetual debt have no fixed date for retirement. Banks provide revolving credit through extension of a line

of credit. Brokerage firms supply margin credit for qualified customers on certain securities. In these cases,

the borrower constantly turns over the line of credit by paying it down and reborrowing the funds when

needed. A perpetual loan requires only regular interest payments. The borrower, who usually issued such

debt through a registered offering, determines the timing of the debt retirement.

2.Repayment Schedule. Payments may be required at the end of the contract or at set intervals, usually on a

monthly or semi-annual basis. The payment is generally comprised of two parts: a portion of the

outstanding principal and the interest costs. With the passage of time, the principal amount of the loan is

amortized, or repaid little by little until it is completely retired. As the principal balance diminishes, the

interest on the remaining balance also declines. Interest-only loans do not pay down the principal. The

borrower pays interest on the principal loan amount and is expected to retire the principal at the end of the

contract through a balloon payment or through refinancing.

3.Interest. Interest is the cost of borrowing money. The interest rate charged by lending institutions must be

sufficient to cover operating costs, administrative costs, and an acceptable rate of return. Interest rates may

be fixed for the term of the loan, or adjusted to reflect changing market conditions. A credit contract may

adjust rates daily, annually, or at intervals of 3, 5, and 10 years. Floating rates are tied to some market index

and are adjusted regularly.

4.Security.Assets pledged as security against loan loss are known as collateral. Credit backed by collateral is

secured. In many cases, the asset purchased by the loan often serves as the only collateral. In other cases

the borrower puts other assets, including cash, aside as collateral. Real estate or land collateralizes

mortgages. Unsecured debt relies on the earning power of the borrower.

6.2 Common Types Of loansConsumers and small businesses obtain loans with varying maturity periods to fund purchases of real estate,

transportation, equipment, supplies, and a vast array of other needs. According to W. Keith Schilit in The

Entrepreneur's Guideto Preparinga Winning Business PlanandRaising Venture Capital,they receive these loans

from a number of sources, including friends and relatives, banks, credit unions, finance companies, insurance


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companies, leasing companies, and trade credit. The state and federal governments sponsor a number of loan

programs to support small businesses. Following are examples of some common types of loans.

SHORT-TERM LOANSA special commitment loan is a single-purpose loan with a maturity of less than one year. Its

purpose is to cover cash shortages resulting from a one-time increase in current assets, such as a special inventory

purchase, an unexpected increase in accounts receivable, or a need for interim financing. Trade credit is another

type of short-term loan. It is extended by a vendor who allows the purchaser up to three months to settle a bill. In

the past it was common practice for vendors to discount trade bills by one or two percentage points as an

incentive for quick payment.

A seasonal line of credit of less than one year may be used to finance inventory purchases or production. The

successful sale of inventory repays the line of credit. A permanent working capital loan provides a business with

financing from one to five years during times when cash flow from earnings does not coincide with the timing or

volume of expenditures. Creditors expect future earnings to be sufficient to retire the loan.

INTERMEDIATE-TERM LOANSTerm loans finance the purchase of furniture, fixtures, vehicles, and plant and office

equipment. Maturity generally runs more than one year but less than five. Consumer loans for autos, boats, and

home repairs and remodeling are also of intermediate term.

LONG-TERM LOANS Mortgage loans are used to purchase real estate and are secured by the asset itself.

Mortgages generally run between ten and forty years. A bond is a contract held in trust with the obligation of

repayment. An indenture is a legal document specifying the terms of a bond issue, including the principal, maturity

date, interest rates, any qualifications and duties of the trustees, and the rights and obligations of the issuers and

holders. Corporations and government entities issue bonds in a form attractive to both public and private

investors. A debenture bond is unsecured, while a mortgage bond holds specific property in lien. A bond may

contain safety measures to provide for repayment.

7 Research Methodology:-This is a case study and the research is based on Qualitative data such as internet, articles, books and interviews

wit senior bankers and Quantitative data. The test that I used in this research is Test of Correlation.

8Scope:-The scope ofthis research is tofindthe connection between Monetary Policyand Non performing loanssothatitcan helpthe bankers;

1) Understanding factormayaffect size ofNPL2) Possible Size ofNPL in Years tocome.

9Type of Research:


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9.1 Data Collection Method:-The data that I had collected from State bank websites and from the Asset ManagementCompany. Also, the datahas been collectedfrom Pakistan Economic Survey 2004-05, PakistanEconomic Survey 2005-06, Pakistan Economic Survey 2006-07, Pakistan Economic Survey2007-08, Pakistan Economic Survey 2008-09.Also, different banking and other financialwebsites has been visitedtoresearchon the subject study.

9.2 Variables:-The variables ofthis researchare,

y KIBOR

y Non Performing Loans (NPLs)

9.3

Hypothesis:

Hypothesis

Ho: There is relationship between Monetary policy and non performing Loans

Ha: There is no relationship between Monetary Policy and non performing Loans

10Literature Review:

The cash reserve ratio (CRR) is a more effective tool in controlling the level of NPLs in the industry as a whole and

the distressed banks in particular. As the ratio of equity to loans advances increases, we should expect the classified

loans ratio to decrease and asset quality to rise, and vice versa.(Journal of Financial Management &Analysis, January

2008 by Adolph us J. Toby).


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Kobayashi and Kato (2001), along somewhat similar lines to Krugman (1998), argue that a change in banks risk

preferences makes them softer about providing additional loans. Once a bank increases its exposure to a firm, the

bank becomes risk-loving and begins to control that firm as if it were a dominant shareholder.

Sakuragawa (2002) develops a model in which a bank without sufficient loan loss provisioning has an incentive to

disguise its true balance sheet so as to satisfy the minimum capital requirement. Berglf and Roland (1997), applying

a soft budget constraint model, consider a game between a bank and a firm in which the bank continues to provide

loans to the firm even after the latters liquidation value plunges following a decrease in asset prices.

Baba (2001), using real option theory, shows that uncertainties associated with the write-off of NPLs - such as the

reinvestment return from freeing up funds by write-off, the liquidation loss, and the possible implementation of a

government subsidy scheme, etc - induce banks to delay writing off NPLs.Barajas and Steiner (2002) also include the

interest rates on deposits and on Government securities as measures of the opportunity cost of private sector credit

for both the suppliers and demanders of credit. Finally, they include two additional Variables specific to the supply

function: the ratio of non-performing loans to total loans and the ratio of loan loss provisions to non-performing

loans. Another story, told by Stein (1994), says that the rise in interest rates increases problems of adverse selection;

thus, banks cut back their loans.

Non-performing loans can lead to efficiency problem for banking sector. It is found by a number of economists that

failing banks tend to be located far from the most-efficient frontier (Berger and Humphrey (1992), Barr and Siems

(1994), DeYoung and Whalen (1994), Wheelock and Wilson (1994)), because banks dont optimize their portfolio

decisions by lending less than demanded. Whats more, there are evidences that even among banks that do not fail;

there is a negative relationship between the non-performing loans and performance efficiency (Kwan and Eisenbeis

(1994), Hughes and Moon (1995), Resti (1995)).

Kishan and Opiela (2000) and Kishan and Stein (2000) find that loans of small undercapitalized banks with less liquid

balance sheet are the most responsive to monetary policy. Besides, Freixas and Rochet (1998) also argue that the

model of Bernanke, Blinder and Friedman (1988) does not accurately describe how modern monetary policy

operates, since the main monetary policy instruments in most developed countries are interest rates not monetarybase.

Monetary policy affects bank loans by altering the bond rate, which in turn affects the interest rate on loans, and

not through changing the size of banks portfolio for a fixed interest rate on bonds, as in Bernanke, Blinder and

Friedman (1988). Peek and Rosengren (1995b) examine the link between regulatory actions and the banks loan

supply more closely, using a balance sheet data of banks in New England for the period of 1989:I to 1992:II. They

find that banks which have been subjected to formal regulatory action curtailed their loans more sharply than those

which have not been subjected to formal action.

Basically, there are two reasons as to why people do not return the loan and resultantly they become non-

performing. These include capacity to pay and intention to pay. Ideally, every loan proposal should be tangibly

backed by both to ensure recovery of loans and minimize the ratio of the level of non-performing loans (NPLs) to

total advances. (Prof Dr.Khwaja Amjad Saeed) (2004). Non-performing Loans (NPLs) generally refer to loans which

for a relatively long period of time do not generate income; that is the principal and/or interest on these loans has

been lei" unpaid for at least 90 days [Caprio and Klingebiel (1999)].

The accumulation of Non-performing Loans(NPLs) is generally attributable to a number of factors, including

economic down turns and macroeconomic volatility, terms of trade deterioration, high interest rates, excessive

reliance on overly high-priced inter-bank borrowings, insider lending and moral hazard (Goldstoin and Turner (1996).


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deServigny and Renault, (2004) submitted that Non-performing Loans (NPLs) has taken a new dimension in finance

just as interest rate and asset and liability management were 15 years ago.

Kassim (2002) suggested some causes of Non-performing Loans(NPLs) as:

y Poor management

y Lack of sound credit policy

y Inadequate credit analysis

y Errors in documentation

y Undue emphasis on profitability at the expense of loan quality

y Fraudulent practices

y Political instability / economic depression

y Abnormal competition

y Policy and regulatory inconsistencies

y Weak real sector

y Political and social influence on bank operators.

From the view of Elaine (2007), Non-performing Loans (NPLs) or credit risk encapsulates the potential loss in the

event of credit deterioration or default of a borrower. Abolo (1999) supported Dorfman's assertion and presented

his own principles of lending under three headings, that is, safety, suitability and profitability of credit, which equally

compel bankers to follow the lending rules.Schall and Halley (1980) outlined the key indicators for loan analysis as

capacity, collateral, capital, condition and character. He concludes that lending involves the creation and

management of risk assets and is an important task of bank management. While being the highest earning asset, the

loan portfolio is also the most illiquid and most risky of banks' operation. The fiscal costs of these impaired loans are

important as well, and vary with the scope and length of the crisis [Cortavarria Luis, C. Dziobek, A. Kanaya and I.

Song (2000)]. Banks are financial intermediaries that sell their own obligations and buy the obligations of others.

(Saeed, 2005).

11 YEAR WISE NON PERFORMINGLOANS (NPLS) FROM FY 2006-07 TO FY

2008-09:

11.1 Year Wise Non Performing Loans (NPLs) 2006-07:


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The non-performing loans (NPLs)ofcommercials banks, specialized banks, and DFIs havedeclinedduring the first nine monthof2006-07 from Rs 220 billion in June 2006 to Rs 203.7billion in March 2007 areduction of7.4 percent. The NPLs ofcommercial banks have declinedfrom Rs 153.0 billion in June 2006 to Rs 142.8 billion in March 2007 andthose ofthe publicsectorcommercial banks have come down from Rs 43.2 billion to Rs 41.3 billion. The NPLs of

the localprivate banks have come down from Rs 107.0 billion in June 2006 and Rs. 99.0 billionin March 2007. The NPLs ofthe specialized banks and Foreign banks have declinedfrom Rs.54.8 billion in June 2006 to Rs 49.1 billion in March 2007 andfrom Rs 2.8 billion to Rs -0.2billion respectively.

11.2Trend of Non Performing Loans (NPLs) 2007-08:The non performing loans ofcommercial banks, specialized banks and DFIs have declinedduring the first six months of2007-08 from Rs. 205.4 billion in June 2007 to Rs. 195.7 billion inDecemberin December2008, areduction of4.7% . The NPL soccommercial banks havedeclinedfrom Rs. 139.5 Billion in June 2007 to Rs. 136.4 Billion in December2008 andthose ofpublic sectorcommercial banks have come down from Rs. 39.8 Billion to Rs. 37.3 Billion. TheNPLs oflocalprivate banks have come down from Rs. 97.3 Billion in June 2007 to Rs. 96.7Billion in December2008. The NPLs ofspecialized banks have declinedfrom Rs. 61.9 Billion inJune 2005 to Rs. 55.2 Billion in December2008.

11.3 Trend of Non Performing Loans (NPLs) (2008-09):The NPL forthe first nine months of2008-09 is recordedto be Rs. 176.7 billion as comparedtolastyearamountofRs. 183.8 billion, overallthere is adecline of3.9%. Private Banks hasreducedits non-performing loans by 1.7% and Specializes bankcontributed withareduction of11.3%. Foreign banks stockofNon- Performing Loansrecordedminorchange as was observedin first nine months of2008-09. Cashrecoveredagainstthe non-performing in the first nine months of2008-09 is less than thatofrecoveredin the sameperiodof2008-09.

12 Total Nonperforming loans in theEconomy:


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Nonperforming loan is the importantfactortomeasure the performance ofthe economy. Asthe Nonperforming is rises itcreates athreattothe economyofPakistan NPLs increasedfrom Rs13.09 billion at end March 2009 to Rs 16.83 billion at end March 2010. Sothe total NPLs ofPakistan as ofMarch 2010 is Rs.452, 023 Million.

12.1Historical Trend of Nonperforming Loans:Year Nonperforming Loans

(Rs. In Million)

2000 240

2001 244

2002 231.5

2003 228

2004 250

2005 580

2006 602

2007 780

2008 1055.6

2009 878.4


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The above graph shows the historical trend on Non Performing Loans of Pakistan from the year 2000

to 2009. As the Years are passing the Nonperforming Loans are also increasing.

13 Loan Pricing Strategies And Table OFKIBOR And NPLS Over TheYears:

Normally, Bank can get a loan on the basis of K+1% and this is cost of bank. Now if customers want to go into

floating then it gave into K+3 % or K+4% depending on the risk factor that higher the risk then higher the interest

rate and vice versa. Now for leasing corporation it costs is K+2.5% and they gave to the customers on K+7% or

K+8% up to K+10% so this thing will be differentiate leasing corporation from bank because in the Banking industry


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there is limitation and boundaries (Upper Lock) but in leasing corporation there is no upper lock. This is a pricing

strategy for banks and leasing corporation.

Serial

No

Dated KIBOR Non Performing Loans

3 2003 1.35% TO 6.5% 228

4 2004 1.4% To 4.4% 250

5 2005 4% To 8% 580

6 2006 8% TO 9.7% 602

7 2007 9.04% TO 10.92% 780

8 2008 10.2% To 13.9% 1055.6

9 2009 10.51% To 12.88% 878.4

From the above table we have seen that as the KIBOR was increasing the Non Performing Loans (NPLS) is also

increasing.

In 2008 the KIBOR was increased up to 13.9% so it created lots of difficulties for banks, leasing corporation and as

well as for consumers. Basically the financial Institution gave loans to the consumers when KIBOR was 10% and

their spread was also high but subsequently when KIBOR reaches to 13.9% so not only their decreased but their

margins of profit converted into negative. So what happened that, Mostly banks wrote letter to the consumers

about revising the loan schedule in which the bank increased their markup. This creates a lot of discrepancy

between the banks and consumers. The consumer said that they had contracted with bank at 9% so they do not

accept the revising of loan schedule. The consumers are right according to their point of so bank also not bear the

total loss. In this scenario some agreed with bank policy some were default while with some consumer the bank

had made negotiation that some loss but some loss must also had to bear the consumer. This is a worst scenario

of nonperforming loans of 2008 which is only due to the KIBOR.

In letter of credit banks finance the loan and gave to the third party on behalf of customer. But this process is also

affected between the banks and customers due to the KIBOR. In LCs mostly imported products came after 4 to 6

months such as equipments, machineries, goods etc. So In 2008 mostly customers mad an agreement at KIBOR =

9% but after six months the KIBOR increases and bank also increased their rates in order to maintain their spread.

So due to this many customers also default. In this another factor that affected from Monitorys point of view is

the exchange rate. In 2007 the exchange

Rate of Pakistani rupee with the dollar is 60.75 Rs/1 Dollar but in 2008 it was rises tremendously from 60.75 RS to

80 Rs/1 Dollar.

This is monetary point of view that how nonperforming loans increases but many peoples intentionally didnt

want to pay the loans. There is example of Hyderabad that UBL had given loans to in the form of Live stocks. Now

these live stocks are basically insured by insurance companies. Insurance companies gave denominations to theirLivestocks by embossing a tag in the ear of live cattles in which each cattle was assigned a serial no that

differentiate the companys cattle from consumer cattles Now many consumers were also default by saying that

their castles were died due to floods. So if the cattle of consumers were died which not including in their liability

the consumer was said your cattle had died in the flood and now they were not able to repay the loan. Then bank

identified the cattles by seeing those Tags but unfortunately the consumers cut the ears of cattles and said that

duet to fighting with other buffaloes their ears had cut and their tag had lost. SO due to this many consumers

were default in live stocks sector.


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12.) Loan Pricing Strategies of Term Finance Certificate of Companies

(TFC's)

6.50%

4.40%

8.00%

9.70%

10.92%

13.90%12.88%

2003 2004 2005 2006 2007 2008 2009

KIBOR

KIBOR


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ny Name Loan Pricing Issue Date Maturity Date Ratings

l Habib Limited. (BAHL) 6 mth KIBOR+1.50% 15-Jul-04 15-Jul-12 AA

wait Investment Company - (PKIC) 3 mth KIBOR+0.50% 9-Aug-05 9-Aug-10 AA+

asing Pakistan Limited - (OLPL) 6 mth KIBOR+1.50% 25-May-07 25-May-12 AA+

asing Limited - (SMEL) 3 mth KIBOR+1.50% 16-Jul-08 16-Jul-11 BBB+

rd Chartered Bank (Pakistan) Limited - SCB 6 mth KIBOR+2% 1-Feb-06 1-Feb-13 Government Guarante

n Cement Limited - (JCL) 6 mth KIBOR+2.50% 10-Nov-06 10-Nov-12 Non Rated Non Investm

Textile Mills limited - (QTML) 6 mth KIBOR+1.50% 26-Sep-08 26-Sep-15 BBB+

Holding (Pvt) Limited - (GHL) 6 mth KIBOR+2.50% 23-Aug-06 23-Aug-12 Non performing Debt S

in Leasing Corporation Limited - (AZLC) 5 Year PIB+2.75% 5-Sep-07 5-Sep-10 Non performing Debt S

as Holding (Pvt) Limited - (AAHL) 6 mth KIBOR+2.50% 23-Aug-06 23-Aug-12 Non performing Debt S

nt Textile Mills Limited - (CTM) 6 mth KIBOR+1.85% 17-Jun-04 17-Jun-11 Non Rated Non Investm

wait Investment Company - (PKIC) 3 mth KIBOR+0.65% 23-Feb-06 23-Feb-11 AA+

wal Cement Limited - (GCL) 6 mth KIBOR+3% 18-Jan-08 18-Jan-13 Non performing Debt S

Nine Limited - (ANL) 6 mth KIBOR+2.25% 4-Dec-07 4-Dec-14 Non performing Debt S

nvestment Bank Limited - (TRIBL) 6 mth KIBOR+3% 17-Jul-04 17-Jul-09 BBB

r (Pvt) Limited 6 mth KIBOR+3.50% 15-Sep-07 15-Sep-11 A

ir Siddiqui & Company Limited - JSCL 6 mth KIBOR+1.70% 4-Jul-07 4-Jul-13 AA

awood Investment Bank - (FDIBL) 6 mth KIBOR+1.60% 11-Sep-07 11-Sep-12 Non performing Debt S

lied Electronic Limited - (NAEL) 3 mth KIBOR+3% 15-May-07 15-May-11 Non performing Debt S

Cement Company Limited - (KCCL) 6 mth KIBOR+1.80% 20-Dec-07 20-Dec-12 Non Rated Debt Secuir

Bank Limited - (FABL) 6 mth KIBOR+1.40% 12-Nov-07 12-Nov-14 AA-

nk Limited - (NIB) 6 mth KIBOR+1.15% 5-Mar-08 5-Mar-16 A+

Bank Limited - (ABL) 6 mth KIBOR+1.90% 6-Dec-06 6-Dec-14 AA-

Commercial Bank - (AKBL) 6 mth KIBOR+1.50% 31-Oct-05 31-Oct-13 AA-

n Mobile Communication Limited - (PMCL) 6 mth KIBOR+2.85% 31-May-06 31-May-13 A+

ak Leasing Company Limited - (SPLC) 6 mth KIBOR+1.50% 13-Mar-08 13-Mar-13 Non performing Debt S

call Telecom Limited - (WTL) 6 mth KIBOR+2.75% 28-Nov-06 28-Nov-11 A

nvestment Bank Limited - (EIBL) 6 mth KIBOR+2.50% 15-Mar-07 15-Mar-12 A

Pakistan Limited - (SEARL) 6 mth KIBOR+2.50% 9-Mar-06 9-Mar-11 A-

estment Bank Limited - (IGIBL) 6 mth KIBOR+2.25% 11-Jul-06 11-Jul-11 A+

akistan) Limited - PACE 6 mth KIBOR+2% 15-02-08 15-02-17 A+

rd Limited - (TELE) 6 mth KIBOR+3.75% 27-05-05 27-11-13 BBB

Bank Limited - (SNBL) 6 mth KIBOR+1.60% 5-May-05 5-May-13 A+

murad Sugar Mills Limited - (SSML) 6 mth KIBOR+2.25% 27-Sep-07 27-Sep-12 A-

ab Fertilizers Limited - (PAFL) 6 mth KIBOR+1.50% 28-Feb-08 28-Feb-13 AA

bas Sugar Mills Limited - (AASML) 6 mth KIBOR+1.75% 21-Nov-07 21-Nov-13 A+

ectron Limited - (PEL) 3 mth KIBOR+1.75% 28-Sep-07 28-Sep-12 A+

Guardial Modaraba - (BRRGM) 6 mth KIBOR+1.30% 7-Jun-08 7-Jun-14 Rated Non Investment

mus Limited - (OPTI) 6 mth KIBOR+2.10% 10-Oct-07 10-Oct-12 A


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Interpretation:-

From these above TFCs we have seen thatas the Year was rising the TFCs spread was alsobecause in these particulars years the KIBOR were increased sodue tothis the TFCs spread wasincreased.

14 Factors Affecting the KIBOR:There are manyfactors thatare affecting the KIBOR. These are notonlyaffects the KIBOR butalsoaffectthe banks Profitabilityandthe Pakistan economy.

14.1Inflation:The inflation rate in Pakistan was last reported at 12.69 percent in June of 2010. From2003 until 2010, the average inflation rate in Pakistan was 10.15 percent reaching anhistorical high of 25.33 percent in August of 2008 and a record low of 1.41 percent inJuly of 2003. Inflation rate refers to a general rise in prices measured against a standardlevel of purchasing power. The most well known measures of Inflation are the CPI which

d Bank Limited - (UBL) 6 mth KIBOR+1.70% 8-Sep-06 8-Sep-14 AA

cial Rec. Securit. Company Ltd. - (FRSCL) 6 mth KIBOR+2% 17-Jan-07 17-Jan-14 A+

Chemical Pakistan Limited - (Engro) 6 mth KIBOR+1.70% 18-Mar-08 18-Mar-18 AA

oyal Bank of Scotland - (RBS) 6 mth KIBOR+1.90% 10-Feb-05 10-Feb-13 AA-

ugar Mill Limited - (JDWS) 3 mth KIBOR+1.25% 23-Jun-08 23-Jun-14 A

Developers (Pvt) Limited - (VDL) 6 mth KIBOR+2.50% 30-Nov-08 30-Nov-13 Non Rated Debt Secuir

Hotels Limited - (AHL) 6 mth KIBOR+3.25% 30-Apr-09 30-Oct-14 A-

Securities - (KASBS) 6 mth KIBOR+1.90% 27-Jun-07 27-Jun-12 A+

Star Hoisery Mills (Pvt) Limited - (TSH) 6 mth KIBOR+3.25% 25-Jul-08 25-Jul-13 Non performing Debt S

rganj Mills Limited - (SGML) 6 mth KIBOR+2.25% 22-Sep-08 22-Sep-14 Non performing Debt S

Alfalah Ltd - (BAFL) 6 mth KIBOR+2.50% 2-Dec-09 2-Dec-17 AA-


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measures consumer prices, and the GDP deflator, which measures inflation in thewhole of the domestic economy.

14.2Foreignexchange rate1 Pakistani Rupee (PKR) = 100 Paisa

The Pakistani rupee depreciated against the US dollar until the turn of the century, when

Pakistan's large current-account surplus pushed the value of the rupee up versus the dollar.Pakistan's central bankthen stabilized by lowering interestrates and buying dollars, in ordertopreserve the country's exportcompetitiveness.

Itis now generallyacceptedthatthe real exchange rate is akeyrelative price in an economy. (1)Changes in the real exchange rate influence foreign trade flows, balance of payments, thestructure andlevelofproduction, allocation ofresources, etc. While the real exchange rate is anendogenous variable that responds to both exogenous as well as policy-induced shocks, the


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nominal exchange rate is usuallytaken as apolicyinstrument. The tworates, however, are foundto be related to eachother. (2) For effective policy-making, it is imperative tohave some ideaaboutdifferentfactors thatinfluence the real exchange rate. Equallyimportantis the knowledgeof the manner in which the real exchange rate responds tochanges in the exogenous variables.While there is a generalconsensus thatthe impactofvarious exogenous shocks on the exchange

rate is transmitted through four broadchannels, namely, (i)absolute prices, (ii) relative prices,(iii) income, and (iv)interestrates, the relative importance ofeachofthese channels is foundtovaryacross countries. In general, itdepends on the degree ofopenness ofthe economyandtherelative effectiveness ofthe fiscalandthe monetary sectors within acountry.

Following is the chart of rupee exchange rates against US dollar. It is interesting tosee that between 2001 and 2007, the exchange rate remained almost the same butwith the start of rise in oil prices and lawyers movement in Pakistan, the rupee totallycollapsed.

Date/year Currency Selling TT & OD Buying TT Clear Buying OD/T.CHQ

30-Jun-1999 UD$ 51.9 51.4 51.3703

29-May-2000 UD$ 51.9 51.4 51.3747

30-May-2001 UD$ 63.5 63 62.88

30-May-2002 UD$ 60.5 60 59.92

30-May-2003 UD$ 57.75 57.55 57.47

29-May-2004 UD$ 57.8 57.6 57.52

30-May-2005 UD$ 59.7 59.5 59.39

30-May-2006 UD$ 60.4 60.2 60.07

30-May-2007 UD$ 60.83 60.63 60.46

30-May-2008 UD$ 67 66.8 66.62

30-Apr-2009 UD$ 80.45 80.25 80.07

8-Sep-10 US$ 85.95 85.75 85.56

14.3TradeDeficitIn recentyears, amajorconcern among the macroeconomists has been the unprecedented growthin government budgetdeficits ofmostof the countries, particularly the developing countries.Large budgetdeficits are found to be associated with, among other things, high interest rates,excessive growthin money supply, highprices, etc. Thus, budgetdeficits are believedtohave anindirect impact on the real exchange rate. Due to inflation and economic crisis worldwide,

Pakistan's economy reacheda state ofBalance of Paymentcrisis. "The International MonetaryFund bailedout Pakistan in November2008 toaverta balance ofpayments crisis andin Julylastyearincreasedthe loan to $11.3 billion froman initial $7.6 billion.

By October 2007, Pakistan raised back its Foreign Reserves to a handsome $16.4 billion.Exceptionalpolicies kept Pakistan's trade deficitcontrolledat $13 billion, exports boomedto $18billion, revenue generation increased to become $13 billion andattractedforeign investmentof$8.4 billion.


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Overthe stretchofthe past six to seven years, Pakistan's trade deficithas only worsenedinsteadof improving. The elementof self-reliance lacking in the mechanismof Pakistan's economy isone major reason as to why Pakistan has to import goods mainlyon heavyprices fromothercountries. In comparison to the heavilypriced imports thatmostly comprise of manufacturedgoods, the exports ofPakistan in the internationalmarketconstitute chieflyofraw materials or

semi-manufactured goods thatare a greatdealcheaperandlesserin demandas comparedtothemarketofmanufactured goods. Anotherfactor thatcontributes towards exacerbating Pakistan'strade deficit is the paucity of variety in the gamut of Pakistani exports. The textile sectorconstitutes amajorpartofourexports andalthoughthe exports ofPakistan have increasedfrombefore they stillcontribute verylittle tothe overall Gross National Productofthe country.

14.4Political Uncertainty:The Pakistani foreign reserves have trembled under political instability and ongoing tensionsoversurvivalofreinstatementofjudges are alsoaffecting the foreign reserves.

Islamabad Chamber of Commerce and Industry President Ijaz Abbasi said here Wednesdaywhile addressing the executive member committee. Political uncertainty is the only factorpushing the marketdown andforced investors tooffloadtheirshares, said Abbasi. He saidtheWorld Bank lastmonth estimated that 33 countries were threatened with political and socialunrest because ofthe skyrocketing costs offoodand energy, and Pakistan is among the list.

He said the dollarrose sharplyagainst the Pakistanirupee and the onlyreason was the lackofpolitical stabilityin the country. Itdefinitelyincreases the trade deficitforthe investors becausewe getfeweramounts formour exports andourimports costus muchdue tothe decrease in thevalue ofrupee.

Topreventa sharp slide ofthe rupee against US dollar, the authorities shouldintervene andtakethe issue seriously; otherwise it willdeplete foreign reserves andaffectthe local businessman,Abbasi said. Itis all-time low levelforthe Pakistanirupee. It shows how weakoureconomyisat this time. All over the world the dollar is losing value against major currencies, and ourcurrencyis going down againstthe dollar, the ICCI presidentaddedanddemandedthe politicalstability to attract more foreign investment in the country. He said the government shouldaddress prevailing politicalissues withoutdelaying the time because in June announce ofbudgetis aheadand the businessmen are looking for that to start theirbusinesses and to redress theirinvestments in the country.He saidthe government shouldannounce acomplete blueprintaccording totheirannouncementofhundreddayplan to enhance trade andforeign exports. He demandedthe political stabilityin

the countrytoattractmore foreign investmentandto boosttrade, foreign reverse and exports ofthe country.


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15 Correlation between KIBOR and Nonperforming Loans:-

YearAverageKIBOR(%) NPL(Million)

2003 2.75 228

2004 2.82 250

2005 7.42 580

2006 9.29 602

2007 9.79 7802008 11.53 1055.6

2009 12.3 878.4

Correlation: 0.61

Correlation between KIBORand Non performing loan is 0.61.Sothere is Correlation betweenKIBORand Nonperforming loans.

0

200

400

600

800

1000

1200

0 2 4 6 8 10 12 14

Correlation

Correlation


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16Hypothesis Steps:

Step 1: Statement

Ho: There is relationship between monetary policy and non performing Loans

Ha: There is no relationship between Monetary Policy and non performing Loans

Step 2: (Hypothesis)

Ho: R=0

Ha: R0

Step 3: (Formula)

Correlation Coefficient= R =:

Step 4: (Calculation)

Year KIBOR (X) Non Performing Loan (Y) (Million)

2003 0.0275 228

2004 0.028 250

2005 0.0742 5802006 0.0929 602

2007 0.0979 780

2008 0.1153 1055.6

2009 0.123 878.4

Total 0.559 Y=4374


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0.00075625 51984

0.00079524 62500

0.00550564 336400

0.00863041 362404

0.00958441 608400

0.01329409 1114291.36

0.015129 770884

=0.05369504 =330686

X Y (X).(Y)

0.0275 228 6.27

0.0282 250 7.05

0.0742 580 43.036

0.0929 602 55.9258

0.0979 780 76.362

0.1153 1055.6 121.71068

0.123 878.4 108.0932

=418.397

Correlation =:

x=0.559,

Correlation =

R= Correlation = 0.59


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Test of Significance:

Z = ln

Z= Z=1.91

Step 5: (Conclusion)

At =0.05 the Z Critical value is1.96 the Z calculated value is +1.91 which lies in the critical region so

there is a correlation between monetary policy and Nonperforming loans.

17 Findings:The findings of my project are as follows:

1) There is a relationship between monetary policy and Nonperforming loans because from the

previous trend that if the KIBOR increased the Nonperforming loans was also increased and Vice

versa.

2) If the Central Bank will decrease their discount rate then the chances of Nonperforming loans

will also decrease.

The KIBOR not only affected the nonperforming loans but it also affected the inflation because the companies can

borrow the loan from bank at higher interest rate and the companies will give their product to the consumers at

higher prices.


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18 References:-y http://en.wikipedia.org/wiki/Economy_of_Pakistan

y www.sbp.org.pk

y http://www.evancarmichael.com/Forums/

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with respect to its inputs and outputs.In Hoque, M and C. Fernandes (ED.)Proceeding of the fifth International Business research conference 2008:Strands ofthe development.

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y Van den Heuvel, Skander J. Does Bank Capital Matter for the Transmission ofMonetary Policy? Federal Reserve Bank of New York Economic Policy ReviewMay (2002b), 259-65.

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y Ismail, Buksh M., and Kashif H. Rasheed, New Evidence on the MonetaryTransmission Mechanism. Brookings Papers on Economic Activity 1 (1990), 149-213.

y Kishan, Ruby P., andTimothy P. Opiela. Bank Size, Bank Capital, and the BankLending Channel. Journal of Money, Credit, andBanking32 (2000), 121-24

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Documents

Final Report on NPL