A new year is an opportunity to wipe the slate clean and start fresh. It’s also a good time to reflect on our actions in the previous year to learn from our mistakes and make resolutions to be our best self in the upcoming months. If we were to extend these practices to Bangladesh Bank, what lessons can be learned from their actions in 2019 and what should they be doing differently in 2020?
2019 has been a bumpy ride for Bangladesh Bank, as news about scams in state-owned banks (and even in private banks), rising cronyism and skyrocketing non-performing loans made headlines. It also did not help that Bangladesh Bank has been making policy changes which have not encouraged loan defaulters or taken precautionary steps to curb scams in the bank.
Let’s Talk About NPLs. Again.
Non-performing loans (NPLs) have been a long-standing thorn on the side for Bangladesh Bank, which has called into question the soundness and safety of the banking sector due to poor lending practices, a lack of corporate governance and the government’s interference.
The International Monetary Fund indicates that a loan is non-performing when payments of interest and/or principal are past due by 90 days or more interest payments equal to 90 days or more have been capitalized, refinanced, or delayed by agreement. A debt can also be classified as NPL if payments are less than 90 days overdue, but there are other good reasons—such as a debtor filing for bankruptcy— to doubt that payments will be made in full. NPLs in Bangladesh are classified as substandard, doubtful, and bad or loss, which is calculated based on uniform criteria. A loan is substandard if it is overdue for 3 months or more but less than 9 months, doubtful if overdue for 9 months or more but less than 12 months, and bad or a loss if it is overdue for 12 months or more.
The size of NPLs in Bangladesh is much higher than in other countries in Asia and the Pacific. From its independence in 1971 until 1999, there was a steady rise in the share of NPLs in Bangladesh, with the gross NPL ratio to total loans in the banking system peaking at 41.1% in 1999. NPLs have increased for all types of banks. The State-Owned Commercial Banks (SCBs) and Development Financial Institutions (DFIs) recorded the highest NPL ratios, as they granted loans on weak appraisal, and under directed lending programs, especially during the 1970s and 1980s. After loan disbursement, the banks’ follow up on repayments was not strong, and such directed lending programs have led to a massive build-up of poor-quality loans, resulting in continued heavy losses. Banks were also reluctant in writing off the long-lasting bad loans mainly due to below standard underlying collateral and fear of probable legal complications. This also contributed to the increase of NPLs in the asset portfolio of these banks.
NPLs in Bangladesh are classified as substandard, doubtful, and bad or loss which are calculated based on uniform criteria. A loan is substandard if it is overdue for 3 months or more but less than 9 months, doubtful if overdue for 9 months or more but less than 12 months, and bad or a loss if it is overdue for 12 months or more.
Numbers Do Not Lie
A cross-country comparison of NPLs is difficult, as there is no universal definition of an NPL and accounting rules vary in different countries. But the 90-day period is widely used by countries to determine a loan to be nonperforming. Cross-country comparison with some countries in Asia and the Pacific shows that the NPL ratio to total loans in 2017 was highest in India (10.0%), followed by Bangladesh (9.3%), Thailand (3.1%), Indonesia (2.6%), Viet Nam (2.3%), Sri Lanka (2.5%), the People’s Republic of China (1.7%), and Malaysia (1.5%).
However, the NPLs of banks rose by a staggering Tk3,863.14 crore in three months till September this year, taking the amount of stress loan in the banking sector to Tk1,16,288.31 crore despite huge facilities in place to regularize default loans. As of September, the total bad loans accounted for 11.99% of the total disbursed loans, according to the latest Bangladesh Bank data. At the end of June this year, the total non-performing loans in the banking system were at Tk1,12,425.17crore or 11.69% of the total disbursed loans.
WHY SHOULD YOU CARE?
NPL is a reflection of the long-term financial health and sustainability of the banking sector. There are four reasons behind this:
- Banking is a business. Unless they earn money on their loans, they will not be able to stay in business. So, interest earned on total assets loans is a critical determinant of a bank’s financial sustainability.
- If NPL grows and banks face a threat to their profitability, they will respond back by raising the interest on loans that will penalize good borrowers and hurt economic growth.
- Provisions can only be kept if banks earn money. The larger the size of NPL, the larger the amount of required provisioning. If profit is being eaten up by NPL, then banks cannot keep provisions for long and will eventually default on their obligations and go out of business. The economic consequence of this will be devastating.
- Lastly, there is considerable global evidence that the financial health of the banking sector is negatively correlated with the size of gross NPL. So, the long-term viability of a sound banking system depends on keeping a tight lid on gross NPLs.
Furthermore, the huge amount of NPL will accelerate the operating costs of the banks, which will increase the lending rates. This scenario will make it difficult for good borrowers to get loans at reasonable rates. This might also result in borrowers not getting loans due to liquidity crunch. A soaring NPL may also exacerbate the liquidity crisis and banks’ ability to pay the money to its depositors, which can potentially trigger the banks’ reputational risk.
HOW IS BANGLADESH BANK RESPONDING?
In January 2015, a number of 15 big groups with more than Tk 500 crore loans in default enjoyed the facility getting their loans rescheduled. A total amount of Tk16,410 crore loans were rescheduled at that time. Officials said the central bank decided not to reschedule loans below Tk 500 crore though the defaulters filed a writ with the High Court in favour of their demand.
One of the conditions of the rescheduling facility was that the borrowers would be marked defaulters, and the benefit would be cancelled if they failed to pay two consecutive instalments. In such cases, they would also be barred from any loan rescheduling benefit in the future. The special rescheduling facilities offered to the big defaulters did not do much to curb NPL. Of the 11 business groups, five have become defaulters again while most of the 11 groups had repeatedly been defaulting on repayment. The overall default loans of these 11 groups ballooned from Tk 15,180 crore in 2015 to Tk 17,103 crore in 2019.
Despite the disappointing results from the previous rescheduling policy, Bangladesh Bank introduced a circular on 16 May 2019 which allowed rescheduling of credit facilities of defaulter borrowers in more favourable terms than the credit facilities enjoyed by borrowers who have been repaying regularly. The circular allowed defaulters to pay only a 2% down payment to reschedule their loans to avail a 10-year loan repayment period with a one-year grace period. The rate of interest for these defaulters have been capped at 9%.
This move by Bangladesh Bank has sent out a clear message to the borrowers that it is better to default than to service the loans regularly. Moreover, the burden of NPL has often been transferred to the taxpayers through treasury transfers. This is not only unsustainable as tax revenues become increasingly constrained, but it is also unethical. In Bangladesh where there are still millions of poor, using tax revenues to bail out public banks because they have loaned out depositor’s money to bad borrowers who often tend to be very rich and powerful would seem to violate all accepted norms of ethics and morality.
Finally, restructuring is a means to avoid the pain of an otherwise good borrower facing unforeseen contingencies. It is not a solution to the NPL problem. Unless it is addressed at the roots by resolving all the weaknesses in portfolio quality, the NPL problem will re-emerge.
RIGHTING THE WRONG
A comprehensive resolution will require the government to bite the bullet and do a proper restructuring of the banking sector based on a sound diagnostic analysis of NPLs of both public and private banks and associated institutional arrangements for regulation and supervision. This diagnosis should be done by a team of experts who are independent and not involved with the present banking system.
A short-cut fix through loan restructuring and redefinition of prudential norms will be like applying band-aid to a cancer wound. Redefinition of prudential norms that are presently aligned to international norms can also jeopardize the international credit risk perception of Bangladesh and must be avoided. The solutions to the NPL problem will need to make a distinction between the stock of NPL and the future flow. The growing stock of NPL suggests that the stock problem cannot be resolved unless the flow problem is addressed.
Scams A Plenty
The roles of the government, particularly the Ministry of Finance and Bangladesh Bank were largely limited to appease bank owners, as they succeeded to amend The Bank Company Act , 1991, reduce corporate tax, and manipulate the pledged 9 % lending rate.
In 2018, banks have no role in stemming soaring NPLs, instead, loan scams of a large magnitude resurfaced in the banking sector. Amid a proliferation of scheduled banks, many of which have been incurring losses for years, the BB stunned the sector by giving permission to another new bank, Community Bank of Bangladesh, to operate.
FARMERS BANK SCANDAL
The Farmers Bank became a hotbed for financial irregularities, just three years after commencing operations, near the end of 2017. Established in 2013, the bank was involved in siphoning off more than Tk3,500 crore, according to Bangladesh Bank. Currently, its NPLs account for 58% of its total outstanding loans.
Muhiuddin Khan Alamgir, board chairman, and Md Mahabubul Haque Chisty, chairman of the audit committee, were forced to resign from their respective posts in November 2017—following corruption allegations. As a result, from January 2018, depositors started withdrawing money from the bank, prompting the central bank and the government to step in and rescue the organization. Later, four state-owned commercial banks—Sonali Bank, Janata Bank, Agrani Bank, and Rupali Bank—and the Investment Corporation of Bangladesh bailed out the bank, buying its equity shares worth Tk715 crore. Managing directors of all five of the aforementioned financial institutions were appointed as directors of The Farmers Bank.
JANATA BANK LOAN SCAM
In August 2018, a loan scam perpetrated by state-owned Janata Bank came to light. A Bangladesh Bank report revealed that Janata bank had lent more than Tk10,000 crore to AnonTex and Crescent Group without complying with the central bank’s single borrower exposure limit criteria.
Janata Bank lent Tk5,500 crore to AnonTex—in clear violation of the Bank Company Act 1991—as it provided 25% of the state-owned bank’s capital base. The law set the single borrower exposure limit to 10%.
Currently, Janata Bank has the most default loans, worth Tk14,376.46 crore. Once considered a strong performer among the state-owned banks, Janata Bank is going through troubled times, former Bangladesh Bank Governor Salehuddin Ahmed has said there is no plan of action insight to solve the crisis. Salehuddin cited a lack of good governance and widespread corruption as major reasons for the current dire situation of Janata Bank. “The politically-appointed bank directors often influence bank officials to sanction loans which cannot be recovered later. Additionally, loyalty to vested groups, corruption, and lack of experience—among a section of bankers—worsens the situation,” he further added.
Other ‘noteworthy’ scams include the Basic Bank and Hallmark incidents. The common factors in most of these scams were the intent of management based on political considerations rather than based on expertise or experience, concentrated power of the Board of Directors, widespread flouting of Bangladesh Bank’s core risk management guidelines by bank officials and, in extreme cases, forgery and other fraudulent practices.
HOW DID BANGLADESH BANK RESPOND?
In the wake of news of massive scams, Bangladesh Bank acted as if it were taking steps to curb the situation. Investigations were carried out by the Bangladesh Bank and cases have been referred to the Anti-Corruption Commission (ACC) for prosecution. In some cases, the bank officials responsible for flouting laws and guidelines were silently removed from the Bank but were not subject to criminal investigation. In other cases, nothing was done.
For instance, in the case of the BASIC Bank, where TK5,000 crore was swindled with/without the help of the banks chairman, Sheikh Abdul Hye Bachchu. In Oct 2019, ACC declared their failure in gathering any information against Bachchu. This becomes even less of a surprise when you realize that in 2009, the government-appointed had Bachchu as chairman and Kazi Fakhrul Islam as managing director of BASIC Bank.
Curse of Cronyism
Crony capitalism with loans to kith and kin of politicians and business conglomerates backed by those in power rules the roost. In short, they hold the banks in ransom. This grotesque magnanimity to the corporates is being attempted to be compensated by recapitalization of banks through public funding, which in other words means that the ordinary Bangladeshis would be bailing out the banks that are still being plundered by the corporates. People with political connections not only find it too easy to get loans from banks the government controls, says Biru Paksha Paul, a former chief economist at the central bank, but face little penalty for defaulting
Public sector banks fulfil an indispensable social necessity and large numbers of poor people need access to finance in a country like Bangladesh. The government must not be allowed to abdicate its responsibility to the common people. It has to end this unholy nexus between the State and big capital to revive the Indian banking system to the needs of the majority of the population.
HOW DID BANGLADESH BANK RESPOND?
The Bangladesh Bank decided to promote crony capitalism by recommending amendment of the Bank Company Act, 1991 which allowed the tenure of board of directors to increase from 6 years to 9 years, and up to four family members would be allowed to be on the Board, instead of the earlier two per family. In the context of an already chaotic banking sector suffering from chronic corporate governance failures, caused by, among others, concentrated powers of the board of directors, this amendment was particularly absurd.
It’s Been A Year of Discontent
In an interview with the Economist, Badiul Alam Majumdar, founder of Shujan, an anti-corruption pressure group, has said, “It’s like the Midas effect in reverse. Everything the government touches turns not to gold, but rather from gold to dust.” He is referring to the countless scams, NPLs and other guffaws faced by the government over the last few years.
While I would not be inclined to even touch this mess with a pole, the article demands that recommendations be provided to improve the position of Bangladesh Bank. Thus here are my few chosen points:
· Corporate governance should be strengthened and careful due diligence followed in lending decisions by banks. In easier terms, it means that all cronyism needs to end when it comes to borrowing from banks.
· State-Owned Banks boards of directors are composed of competent professionals, instead of those appointed on political considerations alone.
· The choice of secured collaterals is important for banks to mitigate the risks associated with loans. To reduce the default risk, fair pricing of collaterals through competent accounting firms with global best practices is necessary.