The root causes of non-performing loans
Non-performing loans decrease the loan giving ability of the banks and it stops the recycling
of banking business
Mohd Jamil Hossain
Effective flow of investments and savings culture is the precondition for the economic development of any country. As a developing country, Bangladesh faces several obstacles such as bad loan culture as well as underdeveloped capital market that mostly depends on the mobilization of the savings and granting credit facilities to the investors by the commercial banks. The performance of the financial sector of our country depends on the performance of commercial banks. It is known to all that the entire non-performing loans shrink the profitability of banks. Banks do not earn interest income from the classified loans. Non-performing loans decrease the loan able fund of the banks and it stops the recycling banking business. For offsetting bad debt loan, banks always try to create a reserve fund, which is created from income of the banks. Bank needs to create high percentage of provision to cover high percentage of non-performing loans. All kinds of non-performing loans reduce the profitability of the banks and banks face low capital base problem which leaves an impact on our banking sector badly.
Credit facilities are the main product and credit granting is very important decision of the banks because it determines the profitability of the banks. At present, banks are so much cognisant in the selection of customers to shun the bad loans or non-performing loans. Non-performing loans are the concerned issue from the last few decades. Developing countries as well as developed countries are facing the alarming increase in non-performing loans. The lending policy of the banks has a decisive pressure on non-performing loans. A default is not completely an unreasonable pronouncement. Rather a defaulter takes into account probabilistic evaluation of a variety of costs and benefits of his decision.
The banking sector of Bangladesh is characterised by low profitability and insufficient capital base because there are scores of banks in Bangladesh. Banks revenues come from spread (Lending rate borrowing rate). The NPL has always raised concerns among policymakers and the central bank took various measures to reduce the increasing volume of classified loans. Bangladesh Bank has adopted various policies, such as, loan re-scheduling facility, introduction of CIB report, waiver of interest etc. to get rid of this excessive volume of NPL. But things have so far failed to produce the desired outcome. Although rescheduling reduces the amount of NPL, it cannot be an end in itself. Loans are rescheduled after the damage is already done.
Although many bank/financial institutions have their own guidelines for risk assessment, the employees working in the credit risk management, particularly at branch levels, do not understand the guidelines properly and depend on their own sense of judgment. So, centralization of credit processing is gradually getting important in the banking arena which also ensure the transparency and accountability. (v) The compliance of internal and external policies for sanctioning of credit facility will be ensured by the business team primarily and credit risk management division secondly and audit inspection division should conduct the audit rigorously on regular interval. (vi) The risk classification/grading system shall be exercised based on sector specific policy, which will guide the bank how much risk banks are taking on their shoulder. Banks are taking risks in each and every credit facility commensurate with the nature of business, however, it shall be within the tolerable limit of risk appetite as set by the board of directors of the bank. (vii) The loan documentation plays a major role for safeguarding the bank interest. Bank should be certain policy in regards to loan documentation and some of the bank are gradually focusing on centralization credit administration function to minimise the risks of internal fraud as well as efficiently handling of documentation formalities like mortgage formalities, loan agreement etc.
The compliance of terms and condition of sanction advice is the responsibility of business team and credit admin team jointly, the credit administration team shall ensure all the compliances are addressed properly and then they should input the limit into the system upon full satisfaction or ensuring full compliance of sanction terms. The disbursement of term loan in particular the phases one shall be allowed phase by phase to ensure the end use of fund which is brighter the prospects of loan collection/refund. (viii) To work out syndicated financing for large loans facility and to diminish the detrimental antagonism among banks in Bangladesh; (ix) Bangladesh Bank should increase the supervisory power and monitoring functions to control the banks that engage in malpractice; (x) Bankers should apply the human skill, diligence, prudence while delivering credit. To ensure this ability of employees, training should be provided. More awareness needs to be developed; (xi) To increase the ethical standards of the bank officials from all bends to create the credit environment trustworthy and vibrant;, (xii) To increase the explicit techniques to differentiate the intractable defaulters from the indisputable ones.
One of the most important tasks of banks today is the follow up and supervision of the credit provided. They are financing large number of borrowers from different sectors of the economy and consequently the supervision of bank credit becomes more challenging than it was before. The main objectives of follow-up and supervision of bank credit are : (i) To ensure that the bank credit is used for the purpose it has been sanctioned for, (ii) to keep a close watch in the borrowers activity and particularly to see if the project has been started in time, (iii) to evaluate the performance of the unit in terms of production sales, profit etc, and also to see if the borrower is in line with the original plan, (iv) to appreciate the management capability, (v) to get information relating to external factors like economic situation, government policies etc, and (vi) to detect signals of sickness at their early stage in order to take corrective actions to avoid sickness. Our banking industry default culture one of the main reasons is to non supervision and monitoring of loan which is called post disbursement monitoring. Bank should have dedicated collection department who will monitor the portfolio up to 150 days day past due (DPD).
The disposal of suit/ cases is very important as till today our legal system does not have such level accountability for early disposal of cases. Besides, the process of serving summon under prevailing law is very cumbersome and lengthy which requires to send notice through postal address, process server and publication of notice in newspapers, in case of non-service of summon. To speedy the process, Government may consider a single process through analysis of legal impact out of above three process for serving summon which will reduce the time significantly. The government may finds the way in co-ordination with central bank for speedy disposal of cases like opening of more court, keeping provision for disposal time period of cases in Money Loan Act. Banks may allow to use the services of recovery agencies for collecting classified loans. The effectiveness of recovery agencies shall bring desired results if the prevailing law and order system of the country is satisfactory. Bank should focus on settlement of court cases outside the court cases through waiver of some amount considering the importance of time value of money. The existing legal framework for recovery of loans encompasses The Money Loan Court Act - 1993, The Public Demands Recovery Act -1913, The Bankruptcy Act - 1997 and some others. It is reported about 73 percent cases out of total suit filed have been settled under Money Loan Court in 2012.
Bangladesh Bank (BB)s latest data as on 30 September, 2016 total provision shortfall money amounted to Tk. 43.81 billion which is lower than Tk. 44.45 billion in June 2016. As per the rules of Central Bank the scheduled banks are bound to keep a certain amount of money from their profits as provision against their classified loans to avoid risks in doing business and keep maintaining capital base. But a good number of banks are facing shortfall due to deficit in their financial capital due to high classified loans and low level of profitability from operation. The government recapitalised an amount of Tk. 12 billion in 2015 despite that the banks capital shortfall was around Tk. 20 billion as of December 2015, according to BB Diagnostic Review Report (DRR). The capital shortfall of the bank increased to Tk. 24.23 billion as of September 2016 the latest report said.
In regard to fierce competition in the banking sector, Bangladesh has 56 scheduled banks, and India, and China have 88 and 126 banks respectively. Government approved the licensing of new banks in 2013 without considering the size of the economy and other factors as needed to allow licensing of new bank. Moreover, Government are considering to give licensee new banks to the different forces last being to Bangladesh Border Guard (BGB) (Simanto Bank), the forces should not be in the banking business rather government can consider their well fare being through other measures.
Since most of these banks are focused on corporate borrowers, the large borrowers enjoy a lopsided bargaining power in our banking sector. Moreover, NBFI, and microfinance institutions had 12 per cent market share of outstanding loans in the whole financial sector in Bangladesh, leaving even smaller pie to fight for the banks, although MFIs, and banks generally operate in quite different segments to serve their customers. As financial intermediaries, banks are likely to be at the forefronts of enjoying the benefits of a growing economy like Bangladesh. However, the current number of banks results in unhealthy competition, which in most cases can be quite slippery slope for the asset quality of the whole industry, as evidenced by the deteriorating asset quality of banks in Bangladesh.
Problems of NPL are such as Stopping Money Cycling, Earning Reduction, Capital Erosion, Increase in Loan Pricing, Frustration etc. As a result, the values of security are increased and the risks of financial recession see a rise. Non-performing loan escorts to the effectiveness problem for the banking sector. Banks do not optimize their assortment resolutions by lending less than demanded. Non-performing loans and performance efficiency are inversely related. So, increase in NPL hampers the performing loan. Most of the cases, it occurs when there is an adverse selection. Averse selection is asymmetric information problem that occurs before the transaction. For example: big risk takers or outright crooks might be the most eager to take out a loan because they know that they are unlikely to pay it back. Because adverse selection increases the chances that a loan might be made to a bad credit risk, lender might decide not to make any loans, even though there are good credit risks in the market place. NPL creates the Credit Crunch situation. Credit crunch is an occurrence that banks ration loan disbursement and new credit commitments in order to protect, but add more risks. Banks treat loan as an asset. They expect return from it. If loans become NPLs then banks have lack of fund to give loan according their commitment or banks could give loans at their previous interest rate. Clients have to pay more. So loans may be defaulted. Credit crunch also increases the rate of NPL.
After the global turmoil, banks globally are now re-examining their business profile against Basel III capital requirements and other strategic priorities. European banks are shoring up their capital levels amid prospects of stricter regulatory oversight. In the coming days, many banks and non-bank financial institutions will face the greatest challenge even to declare good dividends to share holders when they are engaged in fierce competition and customers are moving to cheap funds. Merger and acquisition (MA) will be the final solution for the survival of some banks and non-bank financial institution as the economy is not ready to absorb too many banks and non-bank financial institutions in Bangladesh. It is learnt that the shareholder value of a bank after merger would be greater than the sum of the shareholder values of the parent banks. Mergers generally succeed in generating cost efficiency through the implementation of economies of scale. The government should consider and take bold initiative to start the merger and acquisition of non-performing bank for sustainable economy.
The writer is a banker
