The banking sector has been hit hard by the Covid-19 pandemic
During the years before the onset of the Covid-19 pandemic, there was considerable discussion among Bangladeshi experts about the problems of the financial sector.
Several issues were regularly debated: What to do about the high levels of NPL? How to manage rescheduling of loans? Are interest rates too high, too low, or just right? Is there too much competition in the banking sector or not enough? Should there be fewer banks achieved by merging some of the private banks? What is the role of the state owned banks? Is Bangladesh Bank sufficiently independent or has it become the handmaiden of the Ministry of Finance?
Widespread unease and the IMF
There were warnings of growing difficulties, particularly in the capital markets and the non-banking financial institutions. The IMF has regularly given its views, most recently, in a report that Bangladesh Bank has blocked publication of. The Fund’s views never change, so it is hard sometimes to take them seriously. Nevertheless, there is widespread unease about what lies ahead.
Despite the widespread discussions and debates, little was actually being achieved. The biggest thing that happened was the reimposition of an upper bound on lending rates. The second important action was the stricter implementation of the limits on an individual’s holdings of government saving instruments.
The impact of the pandemic on the economy system was profound: Companies that had borrowed money found their revenues fell sharply and many faced major difficulties in repaying loans.
Two things happened: Bangladesh Bank instructed that loan payments could be delayed until December 31, 2020, that no loan could be classified after December 31, 2019; and that the payments that were due in the last three quarters of 2020 could be handled by extending the length of the loan by a year, delaying he scheduled payments for 2020 to the future. This was to apply to both interest and principal due. If implemented, no loan would be freshly classified during 2020, as all would be rescheduled.
The second major development was the line of credits that Bangladesh Bank opened to enable banks to finance working capital loans so that enterprises could get back into production.
For ease of discussion, we separate enterprise lending into (1) small businesses and (2) medium and large enterprises. We use the amount of the loan balance to define which category a company belongs to.
The table below summarizes the situation as seen through the portfolios of private banks as of June, 2020. We concentrate on the private banks as government owned banks would receive special treatment and foreign banks can manage their own affairs. The data in the table includes the Islamic banking institutions.
For large and medium size loans, some were rescheduled as per BB’s instructions, but many were not. The loan accounts of those not rescheduled were charged but only a limited effort was made to collect the dues as BB has instructed forbearance. The banks charged the interest to the accounts and took this as income.
Those companies that took loans for working capital through the new credit lines applied the proceeds in different ways. In many, perhaps most, instances, increases of production were not forthcoming as market demand was weak. Instead bills were paid, salaries of corporate staff were paid, and possibly loan repayments were made. In the later use, this effectively rescheduled the loan.
When all of this is put together, we will have on December 31, 2020 some loan accounts that are current where the borrower managed to repay. We will have most accounts where the amount due has increased substantially from the addition of all or a part of the amounts due over three quarters from 2020.
Many firms, their finances weakened by the pandemic, will not be able to pay the amounts demanded once the time allowed by BB to defer payment lapses. This will start the clock towards future classification. Such classification would be at least one year in the future, so is not an immediate problem.
The immediate difficulty arises as companies will be increasing output during 2021 as the economy recovers and will need additional funding. The willingness to increase lending further relative to the value of the company is very uncertain. The valuation of the company does not increase, indeed it may decline.
This holds true even if the loan was rescheduled according to the BB Circular described above. In principle, to increase the loan, the borrower would have to produce additional collateral or have existing exposure less than what a prudent bank would lend. Such calculations are particularly difficult as forecasting earnings of companies will be very uncertain for most of 2021.
For companies that are exporting, particularly in the RMG sector, forecasting the level of orders that will be forthcoming is very uncertain; buyers in Europe and the United States are trying to understand the demand for clothing with the second wave of the pandemic now striking both markets. The buyers may be cautious, maybe not. Performance in the retail stores seems better than expected.
For companies focused on supply to the domestic market, the pace of expansion is not completely clear. A reasonable assumption is that the fourth quarter of calendar 2021 should see these firms at the same level of output as the fourth quarter of 2019.
If the required loan repayments could not be made then in about one year the volume of non-performing loans will increase, and earnings of the banks would decline as interest on such loans would go to suspense accounts.
Small business loans
For small business loans, the position is probably worse than for larger enterprises as recovery is weaker. We have defined small loans as those with a balance outstanding from Tk1 million to Tk50 million. Focusing only on domestic private banks, this covers 35% of the amount outstanding and 14% of the number of advances. The amount outstanding on June 30, 2020 is Tk2,712 billion.
We expect a large percent of the borrowers of these small loans will have difficulty paying the dues during the rest of 2020 and the amount owed will increase to the order of Taka 3,208 billion by the end of 2020. Many of these loans will go into default by the end of 2021 and it will prove very difficult for these small enterprises to recover.
The experience of many countries with these small enterprises during the pandemic is that the enterprises simply go out of business. Unless there is a special effort to handle the financing of these enterprises one should be pessimistic about how many will survive and how many loans will be recovered.
A program that would do some good
The proposed program is as follows:
If the small enterprise loan [within the size limits mentioned above] was not classified on December 31, 2019 and had been a customer of the bank for at least two years prior to March 31, 2020, then if the bank reschedules the loan, adding two years to the repayment period, Bangladesh Bank will pay the lending bank the amount of interest and due but unpaid principal accumulated over the period from April 1 to December 31, 2020.
The lending bank will reduce the outstanding amount by this amount. That is, for small enterprise loans, society will take up the increase in dues arising from the pandemic.
There are about 510,000 loans in this category with perhaps 10% classified. The cost of this program would be about Taka 400 billion or $4.8 billion. This is about 1.5% of GDP and would save many of these enterprises and about 10-15 million jobs. Without such a debt forgiveness program for small enterprises, most cannot survive and unemployment will rise during 2021. The cost is high but these firms are essential to the economy.
Survival will be difficult even with this program as the build up of demand for their products is likely to be slow.
Large and medium enterprise loans
For the large and medium size loans, there are about 24,000 loans outstanding with balances above Taka 50 million. This only covers the loans made by the domestic private banks. These loans should be rescheduled immediately, if not already completed, according to BB’s circular.
To ensure that this is done, the Bangladesh Bank should further instruct that its circular must be followed and the date for blocking loan classification shifted from December 31, 2020 to June 30, 2021. Rescheduling these loans can be accomplished by the private banks over this six months period.
There is little point in deferring the date when borrowers become responsible for the full balance of the loan, including the amounts due from the last three quarters of calendar 2020, unless the loans are rescheduled. If the loans are rescheduled per BB’s instructions, no medium or large loan will be classified from the impact of events April to December 31, 2020.
Banks must be willing to increase lending to support rising demand. This will be achieved through the competitive private banks and the clever businessmen and women and bankers. But risks will increase. To reduce risk the overall economy must expand at a robust rate.
The coming crisis
The coming crisis of the banking sector arises from the impact of the pandemic that slowed the economy sharply and the consequent steady but slow recovery of production that will reach end of 2019 levels by the end of 2021. The authorities should set aside arguments about the banking sector and focus on getting through the next year of recovery.
To achieve this growth private investment must increase. Exports are recovering slowly and the Pandemic in the major export markets must give pause to how fast export recovery will take. Government expenditures will increase but expenditures on the ADP will take time to rebuild. Private investment is the key.
At present, the rescheduling of loans will stave off loan classification but still burden enterprises with a higher level of debt than expected.
This debt increment must be rescheduled and the banks must seek ways for the large and medium enterprises to increase their borrowing for working capital that they will need as production increases during 2021.
Otherwise, there will be little interest in new factories, commercial buildings or expansion of existing facilities. Small enterprises will need loan forgiveness as outlined above to survive.
We have sketched here the way to support the rebuilding of private sector investment. Without such a program, economic recovery will be much slower. The work to achieve this is immense.
The central bank is fully able to provide the leadership and supervision to accomplish this program.
The central bank should focus on the immediate crisis and put aside other reforms.
Forrest Cookson is an economist who has served as the first president of AmCham and has been a consultant for the Bangladesh Bureau of Statistics.