Moody, downgraded the Macro Profile for the banks of Bangladesh from, ‘Weak’ to ‘Weak-‘, adding a negative one-notch adjustment to Credit Conditions. The credit rating agency was a party pooper for an otherwise terrific year for the Bangladeshi economy. Growth spurted to nearly 8 percent of GDP, the RMG sector continued to dominate the world market and political stability remained as stable as one could hope for. Yet the thorn at the side seems to be the ailing banking sector whose soundness and safety remains uncertain due to poor lending practices, a lack of corporate governance and the government’s interference.
Default loans at banks went up by a hefty 26.38 percent or Tk 19,608 crore last year, the highest rise in seven years, exposing the precarious condition of the banking sector. The amount of non-performing loan (NPL) stood at Tk 93,911 crore at the end of 2018, up from Tk 74,303 crore a year ago, according to data from the central bank. The NPLs now accounted for 10.30 percent of the banking sector’s total loans, up from 9.31 percent in 2017.
But before we delve further lets understand what are NPLs and why they are bad for the economy.
INTRODUCTION TO NPL: 101
Non-performing loan, also known as an NPL, is a loan where the borrower has stopped paying the installments on the principal (original amount) and interest – it is effectively in default or very close.
Most loans become non-performing if payments are more than 90 days overdue – this will depend on the terms of the contract. As soon as a loan is non-performing, the likelihood of it being repaid in full are considered to be significantly lower.
A performing loan will provide a bank with the interest income it needs to make a profit and extend new loans. When customers do not meet their agreed repayment arrangements for 90 days or more, the bank must set aside more capital on the assumption that the loan will not be paid back. This reduces its capacity to provide new loans. To be successful in the long run, banks need to keep the level of bad loans at a minimum so they can still earn a profit from extending new loans to customers.
If a bank has too many bad loans on its balance sheet, its profitability will suffer because it will no longer earn enough money from its credit business. In addition, it will need to put money aside as a safety net in case it needs to write off the full amount of the loan at some point in time.
Provisioning against defaulted loans will also jeopardize the financial health of many institutions. Banks have to keep provisions against their NPLs as per the central bank’s guidelines. The provision amounts are kept aside from the banks’ profits. When provisioning amounts become higher than the profits of a bank, it has to provision amounts from its capital, which can result in capital shortfalls. Capital shortfalls, in turn, hamper trade activities with overseas banks.
BACK TO REALITY
The banking sector faced a combined provisioning shortfall of Tk12,897crore at the end of June this year, exposing their faltering financial health. Thirteen public and private sector banks are on the list, according to the Bangladesh Bank’s latest data. Of the 13 banks, four are state-owned, while the remaining nine are private commercial banks.
The thirteen banks are Sonali Bank, Agrani Bank, Rupali Bank, BASIC Bank, AB Bank, Bangladesh Commerce Bank, Dhaka Bank, Mutual Trust Bank, National Bank, Standard Bank, Shahjalal Islami Bank, Social Islami Bank, and Trust Bank. Some of the banks faced provisioning shortfall because they lent a large number of funds in violation of banking regulations, it was alleged.
Our new Finance Minister, AHM Mustafa Kamal vowed to eradicate NPLs by saying, “Now NPL becomes a matter of grave concern, but it is still in a manageable position. From today, NPL will not increase and Bangladesh Association of Banks (BAB) will take necessary initiatives to cut the existing classified loans.”
HOW ABOUT A RAIN CHECK?
In reality, however, the NPLs have galloped forward, for which we have the finance minister to thank. His latest idea has been received with raised eyebrows and concerns at home and abroad. I am talking about the brilliant loan rescheduling program.
Loans are commonly rescheduled to accommodate a borrower in financial difficulty and, thus, to avoid a default. On May 16 this year, Bangladesh Bank offered a special loan rescheduling facility for loan defaulters with a 2 percent down payment and a long 10-year repayment facility with a one-year grace period and one-time exit provision with maximum interest waiver. Moreover, there will be no new credit facility for the defaulted borrowers, who are the beneficiaries of the bailout scheme.
And if that were not bad enough, loan write-offs are being considered a policy tool to discourage bad loans. Loan write-offs almost quadrupled in the first quarter of the year on the back of the central bank’s easing of rules, which is yet again a sobering reminder of the banking sector’s deteriorating financial health. A loan writes off occurs when the lender decides that a loan is not collectible and removes it from their balance sheet.
Banks prefer to never have to write off bad debt since their loan portfolios are their primary assets and source of future revenue. However, bad loans reflect very poorly on a bank’s financial statements and can divert resources from more productive activity. Banks use write-offs, to remove loans from their balance sheets and reduce their overall tax liability.
Between January and March of 2019, Tk 557.30 crore was written-off, in contrast to Tk 141.26 crore a year earlier, according to data from Bangladesh Bank. Earlier in February 2019, the central bank revised its policy to allow banks to write-off default loans that have been languishing in the bad category for three years, down from five years previously. Furthermore, lenders do not have to file any case with the money loan court to write off delinquent loans worth Tk 2 lakh, up from Tk 50,000 previously.
However Moody (yes, those pesks again) have reported that granting loan rescheduling and writing off bad loans is more like sweeping the problem under the rug than dealing with the problem itself. And to add insult to injury, they marked down 8 local banks with a negative rating.
The Capital, Asset, Management, Earnings, Liquidity and Sensitivity to the market risk (CAMELS) rating of different commercial banks of Bangladesh, seemed to follow a similar trajectory and listed all the state-owned banks as Marginal or ‘D-Class’ banks and only ICB Islamic Bank to Unsatisfactory or ‘E-Class’.
HOW DID WE GET HERE?
But what has caused this massive upheaval of the banking sector? There are many reasons for the rise of non-performing loans in the banking sector. Political influence is one of the big reasons why defaulted loans are soaring. Political parties have used their influence to secure loans for the desired candidates. Over the years, many high officials have been appointed in the state-owned banks with political influence, who has put the banking sector in jeopardy by unethically giving loans to devious customers. A number of new banks were established on political grounds. Consequently, some third-generation banks were involved in massive loan scams which have resulted in significant damage to the financial health of the banking sector.
Issuing loans to bad borrowers is another reason behind the rise of NPLs. Bank officials lack knowledge about the potential customers, and they wrongly select bad borrowers who later turn into willful defaulters.
Lack of good governance in the banking sector is another important factor behind the rise of NPLs. Big loan defaulters are getting various facilities to reschedule their payment of borrowed amounts. Due to a lack of good governance, this problem is increasing. Enforcement of good governance—accountability, transparency, and rule of law—can bring the banking sector on the right track.
FINAL FEW WORDS
In a scathing article, The Economist has labeled the banks of Bangladesh to be ‘crony ridden banks’, urging all political influence to be stopped when allocating loans and requesting hard action against those borrowers who have made a living off people’s misery. Loan defaulters should be brought to book and their businesses should be curtailed. Bangladesh Bank officials should be able to exercise their power without fear and favor against loan defaulters.
By no means, is the above-listed problems the only issues plaguing the banking sector, and listing and explaining them all is a herculean task, not fit for this writer. As such the recommendations have also been shortened. However, if one is interested, in a very detailed presentation, Centre for Policy Dialogue, a local think tank, has identified the problems and listed the recommendations starting from recognizing the problem for what it is, scraping the exit plans for state-owned banks and upholding the independence of Bangladesh Bank.
One can only hope that the government recognizes the peril the banking sector is in and does more than what the sector requires.