The main objective of the central bank in early 2021 should be to ensure that the private banks manage the aftermath of the pandemic, both by maintaining their capital adequacy ratio (CAR) but also with the continuation of support of their customer enterprises.
Fundamental to this is to strengthen the capital position of the banks.
At the end of 2020, many of the private banks have CARs that are close to the minimum required.
The adjustments from non-payment of loans during the pandemic will increase provisions, reducing capital levels.
There are three steps to protecting the capital position:
1. Managing the impact of the pandemic on loan repayment to ensure that the adverse impact is handled so that banks do not suffer a reduction in capital. For large loans greater than Tk 5 crore, this calls for the implementation of the BB’s notices on loan rescheduling.
2. Preventing any dividend payment that will lower the capital position of the bank. There is no justification for paying dividends during this post-pandemic adjustment period.
On this, the BB must be firm. Unfortunately, the central bank appears to condone the payment of dividends.
3. Implement a loan forgiveness programme for soured loans that had balances from Tk 1 crore to Tk 5 crore. Without such a programme, many enterprises will fail and the private banks will be under severe stress.
When the pandemic hit Bangladesh in March last year, it was clear that many enterprises that had loans outstanding would face difficulties in meeting their repayment schedules.
The BB instructed that the interest charges would be debited to the loan account and taken as income by the banks regardless of whether the payment was made [unless the loan was already classified] while the instalments of principal would be rescheduled by adding these payments to the end of the loan’s current tenure, thus extending the length of the loan.
At first, this applied for three quarters from January to September but was later extended to the end of 2020.
Hence, whatever instalments were due in 2020 would not be debited to the loan account until January 2021.
I believe that the banks could also treat all or part of the interest in the same way.
Many firms might choose to pay part or all of their instalments and interest.
If this notice is implemented, then no loan should then be classified based on the performance of the borrower during 2020.
This programme is sound for large establishments (we define it as having loans greater than Tk 5 crore). But for small business, it is not sufficient.
This note deals only with domestic private banks.
There are four other groups: (1) the state-owned commercial banks, which have complex financial positions that require broader analysis; (2) the state-owned specialised banks, which also require comprehensive treatment; (3) foreign banks that can take of themselves; (4) the non-bank financial institutions, which are private but currently have great financial difficulties requiring more complex intervention.
The impact of the pandemic was not the fault of the banks or the borrowing enterprises.
The costs of recovery should be paid by the whole society.
What is proposed here is to keep the banks from weakening and to reduce economic pressure on small enterprises during the recovery period.
However, the administrative task of carrying out rescheduling is difficult.
There are about 528,000 loans with a balance outstanding of Tk 10 lakh to Tk 5 crore held by the domestic private banks in September 2020.
These are loans to small industries or service establishments.
Such enterprises have faced grave economic difficulties during the pandemic as they are generally lacking the resources to deal with the slowdown of the economy.
The amount outstanding of this group is Tk 2.8 lakh crore and the average loan size is Tk 53 lakh.
We expect that only a very modest percentage of these have been rescheduled.
On January 1, 2021, many of these loans will be in arrears once the instalments from 2020 are added to the account.
If the due date is taken as the originally scheduled date, then on January 1 a large number of loans will be classified and in six months this will increase to a very large amount.
It is unrealistic to expect the enterprises to have the earnings to continue payments and also catch up paying for the instalments that fell due in 2020.
If the due date is taken as January 1, 2021, then it will be several months before classification.
At present, there seems to be no guidance on this point from the central bank.
Whichever way this is handled, a large number of the banks’ customers will face classification and the banks a sharp increase of provisioning requirements.
The economy is recovering but how rapidly is difficult to forecast.
It is better to be conservative in planning for the management of the banks.
I propose a partial loan forgiveness programme to cover the instalments that fell due in 2020 for these small enterprises.
This would leave most of these small enterprises with a limited change in the amount that they owe the bank.
Such a programme partially isolates the small enterprise from the impact of the pandemic, assuming that most of the enterprise earnings were low in 2020.
I have revised the estimates here as follows [we do the calculation for the one year of April 1, 2020 to March 31, 2021]:
The calculation is for the average small loan of Tk 53 lakh. The interest due is Tk 4.8 lakh (9 per cent).
We assume that 20 per cent of this is paid [30 per cent of the fourth quarter of 2020 + 50 per cent of 1st quarter 2021].
Hence, there is an amount of Tk 3.8 lakh interest due and carried forward.
We assume the loan is for three years, so for one-year payment of principal is about Tk 17.7 lakh. I round off the instalment plus interest to Tk 22 lakh that will be is overdue for the loan as of March 31, 2021. This is 42 per cent of the loan outstanding on June 1, 2020.
As many as 510,000 loans outstanding in this category. If nothing further is done then I believe based on information from discussion with bankers that a minimum of 30 per cent of these loans will be classified at least as doubtful by the end of 2021.
This amounts to the classification of Tk 77,300 crore or 9.8 per cent of the loan portfolio. This requires provision (doubtful) of Tk 38,700 crore.
This increases the classified loans of private banks by almost 10 per cent of the portfolio. The increase in provisions comes to almost 5 per cent. This eliminates half of the capital of most of the private banks.
When classification increase to loss then this drives the private sector banks’ capital to zero.
Clearly, there is some combination of write-off and rescheduling needed.
The total amount that comes due allowing for some interest payment is Tk 1.1 lakh crore.
As a rule of thumb, I suggest that 35 per cent of the loan repayment in 2020 be written off and the remainder rescheduled.
This would require Tk 39,300 crore. This is a large amount but is essentially needed to preserve the small enterprises and the private banks.
Our model for the small loans is that the average loan of Tk 53 lakh would be adjusted to Tk 64 lakh [add Tk 22 lakh and subtract loan forgiveness of Tk 7.7 lakh].
The additional Tk 14.3 lakh would be rescheduled to begin being repaid at the end of the existing loan.
To add another 1 per cent of general provisions on the deferred portfolio as the Bangladesh Bank is proposing achieves nothing.
Most of the private banks are way below CAR once they take these unpaid amounts into the accounts and begin to classify the loans.
Reducing further makes the books look worse and achieves no improvement in the future health of the banks.
The purpose of the notice is to pretend that the private banks are in better condition than they are.
In Europe and the US, many banks have done this by taking additional provisions on the expectations that there would be a substantial increase in default loans.
But this is meaningless for Bangladesh, where CAR is already low.
The task of rescheduling will take some time.
Each bank has on average 8,500 loans in this category.
To adjust most of these loans would be a tremendous undertaking to be achieved in one year.
This requires 700 loans per month on average to be rescheduled. The boards would all earn their attendance fees.
The medium and large loans can also be rescheduled, adding on the amount due in 2020 to the end of the loan as the BB wanted.
Much of this may have been done and in any event, the number of loans to be processed is much lower than for the small loan category.
It would also be good policy to extend the period of holding off entering the payments in 2020 loans in the books until June 30, 2021 providing the banks work to complete the rescheduling or alternatively to block any classification until June 30, 2021 to allow more time for rescheduling.
All of these actions are summarised as follows:
1. For the large and medium-size advances [above Tk 5 crore] rescheduling should be required.
The total amount rescheduled would be interest plus instalments for the period January 1, 2020 to December 31, 2020.
Banks would add this amount to the existing loan with the freedom to schedule the repayment for 1-3 years.
This will certainly cause the commercial banks to worry about additional collateral and more importantly an increase in the lending against weaker corporate financial conditions.
But there is no real alternative.
These enterprises need time to rebuild and increase profitability. This is no time to be tough.
2. For the small enterprise loans [loans Tk 10 lakh to Tk 5 crore], rescheduling and loan forgiveness will get these vulnerable enterprises through the next two years as the economy rebounds and profitability returns.
Of the amount due (interest plus instalments from April 1, 2020 to March 31, 2020), 35 per cent would be forgiven and the remainder would be rescheduled for repayment for 1-3 years.
3. Enough time must be given to enable the banks to do all this work.
The banks equally need protection against a large volume of loans going bad due to the pandemic.
The society has to take some of the burden of the losses incurred during 2020.
Unless the small enterprises and the banks are protected from the impact of the pandemic, the result will be a gravely weakened economy.
Loan forgiveness as recommended here will be expensive. But all of the alternatives are worse.
Unless there is aggressive management, the banking system will end up in worse condition.
Everyone will pretend things are better than they are. The small enterprises (with loans of Tk 10 lakh to Tk 5 crore) will face major problem with the additional debt they have incurred due to the inability to repay due to the pandemic.
The BB can allow banks to defer provisioning but the business enterprises are financially crushed.
With rapidly rising loan defaults, dividend payments by banks, and growing difficulties with garment sector loans, the state must take up some of the debt burden caused by the pandemic.
Forrest Cookson is an economist
