VZCZCXRO1710
RR RUEHLH RUEHPW
DE RUEHIL #0229 0341308
ZNR UUUUU ZZH
R 031308Z FEB 09
FM AMEMBASSY ISLAMABAD
TO RUEHC/SECSTATE WASHDC 1274
INFO RHEHNSC/NSC WASHINGTON DC
RUEKJCS/SECDEF WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC
RHEBAAA/DEPT OF ENERGY WASHDC
RHMFISS/CDR USCENTCOM MACDILL AFB FL
RHEFDIA/DIA WASHINGTON DC
RUEHLO/AMEMBASSY LONDON 9552
RUEHML/AMEMBASSY MANILA 3121
RUEHNE/AMEMBASSY NEW DELHI 4374
RUEHBUL/AMEMBASSY KABUL 9745
RUEHLH/AMCONSUL LAHORE 6667
RUEHKP/AMCONSUL KARACHI 0970
RUEHPW/AMCONSUL PESHAWAR 5591

UNCLAS ISLAMABAD 000229 
 
SIPDIS 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: EFIN ECON EINV PGOV PREL PK
SUBJECT: PAKISTAN'S BANKS FACE DETERIORATING CONSUMER AND SMALL 
BUSINESS PORTFOLIOS, PROTECTED FROM GLOBAL CREDIT CRISIS 
 
REF: LAHORE 0014 
 
¶1. (SBU) Summary.  The banking sector in Pakistan has been largely 
shielded from the international financial crisis by a regulatory 
framework that has limited its foreign currency and securities 
exposure.  Although there were no major losses in calendar year 
2008, local bankers are expecting problems to surface in the 
troubled consumer and small business loan sectors in the coming 
months.  The high interest rates (required by the IMF Standby 
Arrangement), while still lower than inflation, have hit the 
troubled textile sector - which accounts for over 20 percent of the 
banks' portfolio - particularly hard.  Banks are working out payment 
schedules with customers to prevent large defaults, but several 
large corporations are in serious trouble.  Lowering inflation, and 
consequently interest rates, is critical to Pakistan's speedy 
economic recovery.  Local interlocuters are expecting at best a 
stagnant rate of growth for FY 2009, rather than the 3 percent 
predicted by the Government of Pakistan.  End Summary 
 
¶2.  (SBU)  Local banking representatives have given us a pessimistic 
picture for the coming year, in particular for their small business 
and consumer loans (which account for over 40 percent of banks' 
portfolios).  Although there have been no major losses or defaults 
in Calendar Year 2008, it appears that this will change in 2009. 
Over the past several years, credit grew by over 25 percent 
annually, with a corresponding decline in the creditworthiness of 
borrowers.  These at times marginal borrowers have been hit hard by 
rising interest rates.  With a 15 percent discount rate, banks 
routinely charge 20 or 21 percent interest; in a country where the 
average per capita income is under $1,000, repayment is becoming 
difficult. 
 
¶3.  (SBU)  As lending to large corporate entities became less 
profitable, banks diversified into the commercial and small and 
medium enterprise (SME) sector, which now accounts for about one 
third of their portfolios.  SME's are traditionally thinly 
capitalized and have low operating margins.  Textile companies in 
the SME sector, such as knitwear, bed linens, and home textiles, 
depend on bank borrowing for their working capital, and have been 
extremely hard hit.  With profit margins of only 9-10 percent, they 
have been unable to repay their working capital loans at the end of 
a product cycle (which banks normally require), and have been 
running up ever larger balances.  Eighty percent of one large bank's 
textile loans have been downgraded.  Even large companies are in 
trouble.  One local source believes that Dewan Salman Fiber, LG 
Electronics, and Chenab Textiles may be close to default [protect]. 
 
¶4.  (SBU)  That the banking sector is not even more troubled is 
largely due to effective regulation by the State Bank of Pakistan 
(SBP), according to one local banker.  Capital adequacy ratios were 
raised to nine percent, and banks now average 13 percent.  When the 
SBP raised capital requirements recently, many smaller banks were 
forced to merge, while those with foreign parents received capital 
injections.  (The SBP plans to increase the minimum capital 
requirement again, to $300 million by 2013.)  Since banks are not 
allowed to borrow offshore and are required to hedge their open 
foreign currency positions with the SBP, they were not exposed to 
foreign exchange risk as the rupee plummeted in value.  The SBP also 
limits banks' exposure to equities to less than 15 percent of their 
capital, which has shielded them from the recent stock market 
volatility. 
 
¶5. (SBU) Comment.  The monetary tightening required by the IMF's 
Standby Arrangement, as well as the GOP's previous extensive 
borrowing (which has crowded out the private sector), have had a 
debilitating impact on Pakistan's small businesses - especially in 
the perennially troubled textile sector, which is also battling high 
energy prices and declining demand.  The banking sector will have to 
monitor its portfolio over the next two or three quarters carefully 
and work out payment arrangements with its troubled customers to 
avoid large numbers of defaults.  Until inflation is brought under 
control, with a corresponding drop in interest rates, the 
manufacturing sector in Pakistan will continue to struggle, and a 
robust recovery will be unlikely. 
 
PATTERSON