• Friday, Nov 22, 2019
  • Last Update : 11:59 am

When being good does not pay off

  • Published at 10:01 pm May 20th, 2019
When being good does not pay off
A broken system Bigstock

The volume of non-performing loans presents a major problem for Bangladesh’s growth trajectory

Bangladesh Bank recently came up with a more liberal framework for rescheduling of the defaulted loans. The new set of policy guidelines, no doubt, take a “creditor in control” approach. The prevalent incentive structure was already skewed against good borrowers, hence the new guideline is going to further worsen the situation.

The defaulters now have the option to reschedule their loans by paying only a 2% down payment of their outstanding amountFurthermore, they will now be allowed a long 10 years to repay. The interest rate is decided to be the bank’s cost of fund plus 3% but has a ceiling of 9%. Defaulters, unlike in the past, can apply for fresh loans too. Whatever the circular preamble says -- it is apparent that there are limited consequences against defaulters in the system.

In the recent past, 11 large business groups have had the opportunity of loans valued at Tk15,000 crore restructured at lower interest rates, and had a longer time to repay. For loans exceeding Tk1,000 crore, the down payment was a mere 1%. Despite their inability to pay their dues back in 2016, the central bank somehow still allowed their loans to be restructured yet again. 

In April this year, the central bank introduced further lenient rules for loan classification. Specifically, instalments would land in the overdue category only after a six-month grace period. Usually, this period has been quarterly. Before, failing to pay merely one instalment would suffice to be categorized as overdue. Longer grace periods -- impacting internal cash generation -- usually threaten liquidity crisis. 

Our loan write-off practice is also faulty. The practice of rescheduling loans without proper due-diligence is harmful. Even those who defaulted intentionally were not held accountable. The lack of accountability is insidious, and has widespread impacts on our economy. 

The volume of non-performing loans (NPLs) has been rising, and this presents a major problem for Bangladesh’s growth trajectory. As of September 2018, the NPLs amounted to Tk99,370 crore -- a 26.28% rise from a year earlier. Analysts estimate a much higher number applying the quality judgment.

The World Bank’s Doing Business Index provides objective measures of business regulations for 190 countries. In South Asia, Bangladesh ranks the lowest at a position of 176th out of 190 countries, and one of the reasons for this is Bangladesh’s difficulties in resolving insolvencies.

NPLs will have widespread impacts on Bangladesh’s burgeoning economy. Firstly, NPLs hinder the supply of credit, fuelling a liquidity crisis. This in turn affects investment and growth. Capital is tied in projects that are not feasible, and this reduces banks’ profitability.

As a result, banks are less willing and less able to lend and invest. With a decrease in investor confidence, Foreign Direct Investment (FDI) is also hampered. This decrease in investment in the economy threatens major macro-economic metrics including growth and employment. 

NPLs also burden public funds. Government bail-outs, especially for public sector banks, can be common. High volume of NPL render monetary policy less effective. This implies that, when governments lower interest rates to stimulate the economy, banks do not respond as much owing to their lower financial capacity and lack of confidence. 

Bangladesh can learn from the experience of other nations in their management of NPLs. In 1998, Thailand and Indonesia had a staggering rate of default loan ratios exceeding 40%. This decreased to only 3% in 2016. Vietnam’s default loan ratio of 17.2% was decreased to a mere 2.34%. 

Our neighbour India, on the other hand, has a ranking of 77th in the Doing Business rankings which reflects a movement up by 54 notches over a period of three years. Prior to India’s Insolvency and Bankruptcy Code (IBC) in 2016, dissolving operations was a time-consuming affair taking four to five years. This duration has now decreased to a year. 

This has had an effect of building confidence among lenders and investors. The mergers and acquisitions industry has boomed following the inception of the IBC. Companies that are indebted are more inclined to try debt restructuring or selling their distressed assets. The recovery rate for 94 cases resolved under the IBC is higher at 43% and up from the 26.5% seen through other mechanisms. Much of India’s success is owed to the IBC and we can learn from its experience. 

The solution of stressed assets for most countries involved the formation of an asset management company (AMC) using government funds. The AMC worked by managing distressed assets. Legislative support for AMCs soon followed with particular laws that would enable AMCs to acquire or dispose bad loans at a faster pace. 

AMCs played a critical role in restructuring banks in financial turbulence, and the measures they took prioritized the security of depositors. In Vietnam, for example, the establishment of the Vietnam Asset Management Company (VAMC) allowed the overcoming of constraints of NPLs in the commercial banking sector.

China’s reaction to NPLs was more severe. Defaulters’ very lifestyles were under watch. 10 million loan defaulters were not allowed to travel by air, purchase tickets for bullet trains, stay at upscale hotels, and apply for further loans and credits cards. They would even be restricted from getting promoted. China’s reactions came after the nation’s NPLs came to a rate of 1.89%. 

Following the lead of our Southeast Asian counterparts can be a way forward for Bangladesh instead of going for regular episodic adjustments. It seems our politicians are only friendly with the under-performing business community, not the performing ones.

Mamun Rashid is a leading banker and economic analyst.