How to handle the state-owned banks � Budget 2016/17
Forrest Cookson
The problem of state-owned banks was on the table in 1985; thirty years later not much has really changed. The banks have poor loan sanctioning discipline, are rift with political interference and corruption linked to loan approval and rarely are able to maintain capital adequacy. The 25 year effort to improve these banks has largely failed. There are some cosmetic changes and a better understanding of the magnitude of the issues but no sustained progress. Resistance to change in the state owned banks is tremendous. The Government is called on over and over to put more funds in the banks to support their failure. But despite or perhaps because of vast funding from the Government no improvement is achieved.
Privatisation of these banks is one objective that has been in favour from time to time. Nothing has been achieved since 1990. Further this is an objective that will never be achieved given the political views and the interests supporting the state-owned banks. To my knowledge there have been two attempts to complete the privatization of Rupali Bank. The first in 1997 was a proposal from the Secretary Banking to simply sell the Government shares of Rupali into the expanding share market and let things play out according to the Banking Companies Act. The privatization of Pubali and Uttara banks had not gone very well; this approach argued we do not know how to organize this so let the private sector work out the new owners. BB would supervise the privatized Rupali and sort out the capital adequacy position. The World Bank recommended against this approach and argued that before privatization the financial situation of Rupali had to be cleaned up and a majority interest sold to a strategic investor. This World Bank/IMF approach was subsequently tried and failed. The reasons for the failure are complex but ultimately the responsible persons were not strong enough to guide the privatization process to completion.
The approach recommended by most experts [given the disaster of the world financial system expert is an odd description] is to clean up the balance sheets, recapitalize the banks, turn then over to an owner with proven banking skills (privatization) and let them operate without government interference but under central bank regulation. Efforts with the state-owned banks have gone down this path and the result is failure.
What to do? The expert view is more of the same. But after 25 years of failure this is not very convincing. The defense offered of poor implementation deserves scorn after 25 years of failure. Another approach is surely needed.
Why are the state banks unsuccessful? There are four reasons:
1. The judicial system provides no support in loan recovery. This weakness undermines all financial institutions, but is particularly fatal for the state owned banks. The courts will not support the banks. Citizens who realize they can get away with it default.
2. The high level of non-performing loans arises since the owner [the Government] does not really care about profitability and the bank staff is prepared to process loans for appropriate compensation. Official compensation of staff is unrelated to either individual performance or the institutions performance. Ultimately bad loans increase, capital is reduced below the BB requirements and following the current approach Government forks up more funds to recapitalize the banks.
3. There is no end to this treadmill. Loan applicants can always find support from some politician or bureaucrat and loan approval will go forward irrespective of the quality of the loan. Contrast this with the private banks where the owners have every interest in preventing the growth of non-performing loans. There is certainly some corruption in private bank loan sanctioning, but nothing like the state owned banks.
4. Finally, the Bangladesh Bank does not enforce capital adequacy. For the private banks BB has effective power which, properly used, forces private financial institutions to improve their performance (i.e. make good loans). But for the state banks capital adequacy is for the future. This is really all talk without meaning: Recapitalization of the state banks has no immediate impact on the Government deficit or inflation. The point of capital adequacy is to prevent a private bank from shifting its bad loans to the Government, putting the burden of covering bad loans on the tax payer. When a reasonable level of capital is maintained and the bank makes bad loans this causes the owners of the bank to lose, not the tax payer. This is surely better than the public having to bail out the bank.
To break out of this cycle of the last 25 years there is a simple approach that costs the Exchequer less and leads to the highly desirable outcome reducing of the importance of the state banks in the financial system.
The rule is to allow the state banks to expand their gross loans by a maximum of 5% per annum.
Gross loans = net loans + provisions + interest in suspense
Gross loans mean the outstanding loans. Provisions are allowances made by the bank to cover bad loans. Interest in suspense is interest due from non-performing borrowers but not paid and is not taken as bank income.
Gross loans are what the borrowers have taken from the bank (net of any repayments made). Net loans are what is left after taking out provisions and unpaid interest.
If the bank can reduce provisions and interest in suspend (by good banking) then net loans can increase faster than the 5% limit on gross loans. Good performance is rewarded. But if the non-performing loans increase then the bank cannot make less new loans.
Under this approach the capital adequacy rule is set aside for state owned banks. The Government stands behind the depositors at state banks so there is no possibility of depositors losing from bank failure. Then there is no need to build up capital adequacy for the state banks. Instead there is a regulatory rule that will enable the bank to do well if it makes good loans but if it does not then it new lending is limited.
The proposed rule will reduce the peculiar, unnecessary budgetary impact of recapitalization. It the state-owned banks cannot improve their operations (i.e. by reducing non-performing loans) then the importance of these banks will shrink. The operational role of Government in the financial sector will shrink, a much to be desired outcome. The Governments proper role is regulation not banking!
There are three more points related to the state owned banks.
1. The rescheduling of loans must follow strict rules; provisions or interest in suspense reduced by rescheduling should not be allowed on the books to reduce provisions or interest suspense for one year after rescheduling. The rescheduled loan must perform according to the agreed rescheduling agreement or provisions or suspended interest cannot be reduced. Rescheduling is a useful tool of the banker but must be used to achieved improved enterprise performance.
2. There is no reason to save BASIC bank. Close it down. Most of the current depositors are Government organizations. Better to not pay them since making deposits in BASIC Bank was a foolish step and those who have left deposits there should pay for their folly. However, if the Government wants to honor these deposits let it do so. Outstanding loans of BASIC should be handed over to any private group including banks that wants to take these loans over and split collection 50-50 with Government. There is absolutely no reason to allow this bank to continue to function. This is a dead institution and it is time to bury the body.
3. The specialized banks raise a whole mares nest of problems as their NPLs are very high. The MDs of the banks have made no serious attempt to recover loans. A review of their loan collection authority will reveal there are powerful tools available for loan collection. The above 5% rule should be enforced for these specialized banks and a special loan collection unit established to begin to utilize the stronger legal channels.
The Government has no appetite for privatisation and the experience of Rupali Bank is that it will not work. The only realistic strategy that will help the financial system to make good loans is to punish poor performance.
In Bangladesh the outcome will be the reduced importance of the unsuccessful banks in the financial system. In the end they will simply be too small to worry about. Continued recapitalization of state banks achieves nothing. The writer is a noted economist
