What our policy-makers can learn from India
The volume of non-performing loans (NPLs) has been persistently rising, and this presents a major problem for Bangladesh’s growth trajectory. As of September 2018, the NPLs amounted to Tk99,370 crore, and this was a 26.28% rise from a year earlier.
The World Bank’s Doing Business Index provides objective measures of business regulations for 190 countries. In South Asia, Bangladesh ranks the lowest in the World bank’s doing business ranking at a position of 176th out of 190 countries, and difficulties in resolving insolvencies is partially responsible for our ranking.
NPLs can cripple our economy
NPLs will have widespread impacts on Bangladesh’s burgeoning economy. Firstly, NPLs constrain credit supply, making a liquidity crisis more likely. Capital is caught in projects that are not feasible, and this reduces banks’ profitability.
As a result, banks are less willing and able to lend and invest in new projects. With a decrease in investor confidence, Foreign Direct Investment (FDI) is hampered. This decrease in investment in the economy influences major macroeconomic metrics including growth and employment.
When NPLs involve the government bailing out banks, as is often the case for public sector banks, they present a substantial burden to public funds. High volume of NPLs render monetary policy ineffective. This is because 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.
Our policy context
The underlying cause of our high NPLs can be traced back to our policy context. Our policy-makers have a “creditor in control” outlook. The current incentive structure favours bad borrowers against good ones.
Eleven large business groups have had their Tk15,000cr loans restructured at lower interest rates and have been given a longer time to repay. For loans exceeding Tk1000cr, the down payment was only 1%.
Despite their inability to pay their dues back in 2016, Bangladesh Bank is still allowing their loans to be restructured again. Until August 16, the defaulters could reschedule their loans by paying only 2% down payment of their outstanding amount.
Moreover, they will now be allowed a lengthy 10 years to repay. It has also been made possible for defaulters to apply for fresh loans -- ramifications against defaulters remain insufficient.
To make matters worse, in April 2019, the central bank relaxed the rules of loan classification. Specifically, instalments would land in the overdue category only after a six-month grace period.
Generally, this period has been much shorter -- a month or three months. Previously, failing to pay merely one instalment would suffice to be categorized as overdue. Longer grace periods can threaten the economy by making a liquidity crisis more likely.
Our loan write-off practice does not help the situation either. The practice of rescheduling loans should include comprehensive analysis and investigation. Even those who defaulted intentionally escaped consequences.
The Indian case: IBC
The Insolvency and Bankruptcy Code (IBC) of India came into effect in 2016 as a response to rising NPLs. While there were large macroeconomic objectives at play such as solving the twin balance problem, developing a robust corporate bond market and improving the credit environment, the new code was primarily designed to streamline the corporate insolvency resolution process.
The IBC has since received praise from the World Bank and IMF and has materially contributed to India’s improved ranking in 2018’s “Ease of Doing Business” by 33 places up from 100th in 2018 to 77th in 2019. As of December of 2018, IBC has resolved cases with debt worth a total Rs300,000cr.
Key aspects of the IBC
There are key aspects of the IBC that are worth highlighting. IBC fundamentally proposes a paradigm shift from the existing “debtor in possession” to a “creditor in control” regime. It would aim to resolve insolvencies in a timely manner -- the evaluation and viability determination must be completed within 180 days.
The “waterfall mechanism” is the order of priority in which the funds from the sale of assets are distributed. Notably, government dues and equity shareholders rank lower than unpaid dues to workers and debts owed to a secured creditor.
An insolvency and bankruptcy board was constituted as an independent body for the administration and governance of insolvency and bankruptcy law; and information utilities as a depository of financial information.
Key regulatory changes in India in recent years
In addition to the IBC, there are notable regulatory amendments to further improve the situation. The revised RBI guidelines overrode earlier laws issued by the RBI to create a clean slate. It was mandated that defaulting loans above a certain amount were to be resolved by September 2018.
If resolutions were to involve any restructuring, even standard loans would be categorized as a NPL. In the scenario where there are no resolution plans by September of 2018, banks would have to launch standard insolvency proceedings. This covered 50 large borrowers.
To fine-tune the IBC and plug loopholes, there were further alterations. Home-buyers are treated at par with financial creditors. Home-buyers can also take builders to bankruptcy court. Lenders to decide turnaround or liquidation decided through a 66% vote, down from 75%.
This makes decision-making faster and easier. To widen the tool for potential bidders who could bid for bankrupt funds, the criteria for bidders was redefined. IBC also gives MSMEs (micro, small, and medium enterprises) promoters to bid for their enterprises that are undergoing corporate insolvency resolution (CIR) provided they are not willful defaulters. This is a big relief for MSMEs.
India has supplemented their efforts with amendments to corporate law. Companies can issue their shares at a discount to its creditors when their debts are being converted to equity as part of any statutory resolution plan. Companies that have defaulted on their payments to any banks, public financial institutions, or any other secured creditor are obligated to seek approval from lenders in order to pay managerial remuneration.
There have also been changes made to local tax laws. The local tax laws provide relief for companies covered under the IBC. This permits carry forward, set-off of business losses if there has been a change in the shareholding structure, reduction of aggregate amount of unabsorbed depreciation, and brought forward losses from book profit for minimum alternative tax purposes.
The market regulator, ie Securities and Exchange Board of India has exempted companies under the IBC from adhering to prescribed delisting norms with certain riders. To expedite insolvency resolution for start-ups, small companies and unlisted companies with assets worth less than Rs1 crore, regulations have been implemented. The notable feature is that the resolution of such cases has to be completed within 90 days (extended by 45 days in certain circumstances) as compared to 180 days.
There have been guidelines introduced on the sale of stressed assets by banks. Banks’ boards would have to formulate a clear policy and lay down guidelines for sale of NPA assets including identification of the assets to be sold, the norms and procedures for their valuation and sale, provisioning, etc.
The process of identification of NPA assets for sale should have a top down approach, with active involvement of head office/corporate office of banks and should take place at least once every year, preferably at the beginning of the year.
Each bank, in line with its policy, should identify a list of stressed assets to be made available for sale during the year. At a minimum, all assets classified as “doubtful assets” category above a pre-defined threshold should be covered. Banks must periodically review the efficacy of their policy and amend when appropriate, in line with their laid-out principles.
“Project Sashakt” is another initiative undertaken by India to address bad loans, strengthen credit capacity, improve credit culture, and portfolio of public sector banks. Project Sashakt guides the resolution of bad loans, depending on their size. It includes an SME approach, a bank-led resolution approach, an asset management company (AMC) or alternate investment fund (AIF)-led approach, an NCLT or IBC-led approach, and an asset trading platform approach.
It is anticipated that most of the banks will come together to sign inter-creditor agreements that would aim to speed up the resolution process -- under the framework of Project Sashakt.
We can see how the IBC would be effective. IBC has instilled a sense of urgency among all stakeholders to resolve bad loans in India. The fear of losing control over their companies has prompted various promoters to settle or resolve their dues before action is initiated under IBC.
While amendment in the Company’s Act & Finance Act would facilitate successful resolution of big corporates, the recent MSME amendments are expected to help bring about resolutions in the small and medium enterprise space also. The proposition of the government to introduce cross-border insolvency wherein lenders can access overseas assets of stressed companies will further strengthen and bolster IBC.
India has tremendously benefited from the new policies. 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 only a year.
This has positively impacted the confidence among lenders, and investors. The mergers and acquisitions industry has boomed following the inception of the IBC, because companies that are indebted are more inclined to try debt restructuring or selling its distressed assets. The recovery rate for 94 cases resolved under the IBC is higher at 43% up from the 26.5% seen through other mechanisms. Much of India’s success is owed to the IBC, and our policy-makers may use its experience as a guide.
Bangladesh policy-makers must react appropriately, and quickly, in response to the ballooning loans, before it is too late. As India’s experience with solving its own problem of NPLs would suggest, this would involve holding borrowers accountable, imposing time-constraints, and encourage clarity in process. Not episodic political efforts, only necessary legal reforms can help Bangladesh get rid of the perennial loan defaults.
Mamun Rashid is a partner at PwC. This long-form is an excerpt of a position paper.