The financial sector presents the government with many difficulties. The evolution of the economy has placed the burden of financing the economy on the banking sector. The capital market has not developed, resulting in very limited contribution to financing investment. The insurance sector has also failed. In both instances poor supervision and lack of action to prevent criminal behaviour have undermined these important components of the financial system.
The closely related asset management companies have been supervised against the interests of the investors and in favour of the owners. The failed regulatory regime has prevented the emergence of well-run mutual funds, the important means of allowing middle class citizens to invest in the capital market with lower risk. Similarly, two key markets -- rice and land -- have not developed in a systematic manner and have received little attention.
Rice is one of the central production activities in the economy but there is no private warehouse system enabling rice to be stored and warrants issued. These warrants can then be traded, increasing the liquidity of the agricultural sector now dependent on the banking system. Land is the most important asset in the nation but there are endless disputes over land ownership. This inhibits the growth of manufacturing, solar power stations, housing, etc. Efforts by the government to establish ownership and allow trading of land to be prompt and secure have failed.
The result is virtually complete dependence on bank loans. The condition of the banking system can be summarized in one number -- as of September 2024, 17% of the loans are non-performing, that is these loans are not being repaid. This is certainly an underestimate. Furthermore the criteria for classification are being changed. These new rules will increase the volume of NPLs. But this is a waste of time. One should concentrate on collecting the loans already identified as non-performing. Later one can return and identify new NPLs from changed classification rules.
Enhanced confidence in the banking system will arise when loans are actually being collected not by explaining that everything is worse. This condition of widespread defaulting on bank loans has been a characteristic of the banking system for as far back as there are records. Those persons who have taken the loans are simply stealing the money from depositors. The banking system is upside down. Rather than using savers’ money to support good investments, we have investors stealing the money for their own enjoyment with the help of the bank directors and staff.
With existing levels of NPLs, the interest rate required for a bank to be profitable is 20% [cost of bad loans 12% (assume collateral covers 30% of loan); cost of deposits 6%; returns to capital and taxes 2%]. Operating costs are largely covered by fees. Manufacturing establishments cannot work with such interest rates. Unless banks charge such high rates, their costs will not be covered. Only by growing rapidly can one survive -- this is effectively a Ponzi scheme and that is the best description of the condition of the banks now.
This is not to suggest that much of the funds have not been well invested; manufacturing growth has been strong and the expansion has been funded partly on retained earnings and partly through bank loans. The benefits have fallen mostly to the owners of the factories.
When a loan is non-performing, the lending bank should: Through the courts take possession of the factory or place of business along with the collateral. After sale of these assets, any surplus can be returned to the borrower.
The only way the banking system will improve is to get loans repaid. The three suggested policies are all pointed towards this objective. Fixing bad banks is not the way forward. The efforts by the IMF and the World Bank are theoretical, mistaking real-world change for formal neatness. Fixing the banking system does not need large complicated time-consuming studies.
The following three points will bring immediate results:
Court System. The worst thing that can happen to a borrower who has not repaid his loan is to be taken to court. Borrowers fight this by stalling in the court, prolonging cases and then refusing to accept the court’s judgments forcing another round of court cases to enforce the original judgment. Once the courts are promptly reaching judgments, enabling the bank to take possession of the collateral and other assets of the borrower, defaulters will begin to repay the loans rather than ignoring their obligations. Surely it is obvious that if a large number of borrowers are getting away with defaulting, then other borrowers will be tempted to do the same.
The Chief Adviser and the Chief Justice must agree on a program to strengthen the courts’ management of cases of non-payment of loans. The court actions must be prompt and there should be no consideration of claimed misfortunes.
To strengthen the Money Loan Courts: (1) Fifty new judges should be assigned to the Money Loan Court benches. (2) A training program should be established for all judges with review seminars every six months. (3) Conditions for appeals should be prepared and such rules should discourage appeals, requiring new evidence and should not be automatic. (4) Rules for management of such cases involving banks should be spelled out. Loan recovery cases involving banks are very simple and should be resolved quickly. (5) Implementation cases should be handled by other Money Loan Benches, not other courts. (6) An automated system should be installed that would produce on a monthly basis a report on the courts’ activities available to the public. This report should cover new cases filed; actions on all cases in the court during the reporting month; cases for which judgments made; new implementation cases filed; progress on all implementation cases in the Money Loan Courts; recoveries made by the banks from disposal of collateral; net position of bank on loan: owed amount, provisions applied; net loss in recovery process.
The past few years have seen poor performance by Money Loan Courts. If this cannot be improved then the banking system will face continuation of what has happened in the past and actual real economic growth of GDP will be 2-3%. It is wrong to blame the condition of the banking system on a few borrowers. Most of society has been involved.
Rescheduling loans: It is important to help enterprises succeed. Businessmen consumed by greed are comfortable stealing bank loans. Their failure to pay for the loans emerges quite quickly and the bank’s loan officers will usually be aware of the actual situation. When it becomes clear that the borrower is not going to be able to repay the loan, the bank should form a team comprising engineers, financial analysts, and management experts.
When a loan is overdue or the loan officer is concerned that it will become overdue, the bank should discuss with the borrower his intentions and if he wishes to reschedule. If not, then the loan should be sent to the Money Loan Court. If the borrower would like to reschedule then the team would review the project and determine if there is a way to make the project profitable and able to repay the loan. If the bank and borrower can agree on a program of actions then the loan will be rescheduled.
The current rules for rescheduling are laughable and have effectively destroyed the banking system. The hard-headed approach described here and typical of sound banking systems would slowly lower the burden of non-performing loans.
Collateral verification: Most loan collateral is land. Banks should review collateral on all loans and check it again with the land registration system. A special land registration department would be established to verify all land used for collateral. If collateral is faulty then it must be replaced or the case taken to court.
This innovation would protect the bank for future loans and would strengthen the efforts to recover loans when the Court orders such actions. Although it will take a long time, the computerizing of land records should be accelerated. Improved land ownership records will make loan management much more effective.
Forrest Cookson is the Research Advisor to the Centre for Research and Development. In Bangladesh, he led the central bank component of the Financial Sector Reforms; was the Team Leader of the study of Northwest Area Development of Bangladesh; and served as the Statistical Advisor of the Legal and Judicial Capacity Building Project.
