Surge in non performing loans in banking sector: Learning from neighboring countries on combating NPL

There is no precised universal definition; however, Non-Performing Loan (NPL) is an asset held by a bank or financial institution that does not generate the expected return. On the other side of the ledger, it is an outstanding loan on which the debtor has not kept up with the scheduled payments. Globally, NPL management is a story affair that most of the banks are struggling with. In Asia, China’s NPL shot up when the banks increased credit supply as an effect of reduction of interest rate. Side by side, lack of regular monitoring also came to an aid in rising NPL. China, now called the debt exterminator, removed their PLs via wide interest margins to clean up its debt-laden system. The upside of wide interest rate margins is that banks are more likely to make huge profits. If the lending rate is 5% and deposit rate 2%, the margin will be 3% and this is the source of profit for the banks. This margin also helps cover NPL-derived losses. In China, the government used this ‘tactic’ to exterminate lethargic companies that lose out cash and default on loans regularly. The then Chinese government closed down failing companies and broadened interest margins – the gap between lending and deposit rates, which ensured that banks could slowly service bad debt.

NPL is one of the significant issues of banking sector in Bangladesh for most recent couple of decades. In spite of close observations by the Bangladesh Bank, NPLs hopped by over 20% or BDT 150.37 billion to the end of June this year from December a year ago. The volume of NPLs rose to BDT 893.40 billion as of June 30, 2018 from BDT 743.03 billion as of December 31, 2017. The offer of characterized credits achieved 10.41% of the aggregate remarkable advances amid the period under survey than that of 9.31% a half year back.

Why Bad Loans are shooting up?

  • Aggressiveness toward portfolio expansion: Excessive competitions among Bangladeshi banks are pushing the banks to extend their portfolio aggressively. As a result, most of the clients are over-financed and there is a risk of fund diversion among the customers. Due to this phenomenon, the same customer is availing excess fund than his/ her requirement and out of repayment capacity. This is a key reason of NPL.
  • Lack of Proper Documentation: Documentation gap is another huge problem in mounting NPL. When any legal action is necessary against the bad credit, FI’s are facing difficulties to go for appropriate legal action due to lack of proper documentation.
  • Insufficient collateral: There is insufficiency in collateral acquisition at the time of credit disbursement, FI’s are not getting proper collateral to make the disbursement secure. In our country, mostly credit is unsecured or even if it is secured, the security is not sufficient for FI’s to pull of the default.
  • Volatile Business Environment: The business environment of Bangladesh is quite volatile. The businesses pertaining to agro based or agro based products, natural calamities have a huge impact on the overall business success of our country, some businesses fail because of the loss incurred from the natural calamities. Besides, the issues related to infrastructure are not sorted in Bangladesh; hence, SME entrepreneurs are much prone to these volatilities. Then again, market is always fluctuating in some or other parameters for the business owners.
  • No Strict action against habitual defaulters: There are very few punitive actions regarding strict measures against a willful defaulter, which has been the case in developed and developing countries. If such actions were taken, it would discourage tendency to default.

Overall NPL Scenario in Bangladesh and Comparison with other Countries

Bangladesh is facing some real challenges to manage the NPL inclination. In order to mitigate this issue, Bangladesh Bank is closely monitoring the FIs and different measures are taken throughout the years; however, statistics shows that the condition is worsening day by day. NPL ratio of Bangladesh stood at 10.8% in March 2018, compared with the ratio of 9.3% in the previous quarter. The highest NPL was in 2003 March which was 28% and lowest was in December 2011, 6.1%. The international standard is to keep NPL under 2% which Bangladesh could never achieve or even come closer to that standard. Considering the Asian countries that had a high NPL, many of these countries were really effective to lower it down to the benchmark or really close to benchmark. For example, China did a good job to curb down the NPL under the desired level.

Among South Asian countries, Sri Lanka and Nepal showed impressive bad loan rate; however, the most alarming issue which can be discerned from this statistic is, Bangladesh is having the worst NPL among all these countries.

NPL and SME sector of Bangladesh

Although SME is the most profitable area of financing in Bangladesh, the NPL rate in SME is rising. SME sector clients are not as structured as the regular clients which are commonly known as the corporate entities. So the credit disbursement for this sector is really challenging. According to the study, a total of BDT 1,36,176 crore credit was disbursed to the SME sector in 2016 while the amount of default loan stood at BDT 22,494 crore, which means that in 2016 the NPL for SME sector was 16.5%.

How Asian countries addressed NPL?

Many successful stories have been created by the western historical strategies. There are some countries in Asia that can be a good example of a successful to reducing NPL from the mountain peak. China, Malaysia and Thailand demonstrate good example of effective NPL management. All these economies had to go through hard way to manage NPL into a lower level. China and Malaysia brought NPL below the international benchmark.

China

China penalized the defaulted customers by putting restriction on enjoying different social benefits that the regular citizens are entitled to avail. Restrictions are namely not being able to purchase air ticket, purchase tickets of high-speed train, serve as executive or representative of corporate entities, avail further credit requests and getting banned on personal ID that is used to avail the hotel accommodation facilities. This blacklist contains many political bodies, legislative and government staffs of China and there is no exception in punishment. Even, they cannot buy any real estate. In some cases, the defaulters do not get any promotion upon being defaulter. In some of the provinces of China, the defaulters are socially and publicly shamed. For Example, in August, a court in the Southwest Sichuan Province began leaving recorded messages on the phones of 20 debtors. When someone rings a defaulter, the essage plays: “The person you are calling has been put on a blacklist by the courts for failing to repay their debts. Please urge this person to honor their legal obligations.”

Malaysia

Malaysia blacklisted their overdue clients. Defaulters in Malaysia are not allowed to leave the country. Besides penalization, Malaysia went through a major restructuring of credit disbursement. Malaysian government used a recovery strategy in a non-cash format to settle down the outstanding loans, which is by converting non-cash recovery asset or collaterals into cash. Malaysia introduced Asset Management Companies (AMC) to extract these loans.

Thailand

Like Malaysia, Thailand founded the Thai Asset Management Corporation (TAMC) in 2001, which has similar structure to Malaysian AMC model. The Thai authorities established TAMC in 2001 with funding from the Financial Institutions Development Fund (FIDF), which guaranteed the issued bonds. Before the establishment of TAMC, each bank set up its own asset management company; however, these private asset management companies could not significantly clear the amount of NPLs. As appraised by the FIDF, the pricing of private bank NPLs was derived from their collateral value. The TAMC is tasked with the acceptance of transfer of sub-quality asset and its management. Towards the realization of such objectives, TAMC has unprecedented encompassing powers, such as establishing of limited companies, guaranteeing credit for debtors, and lending money to debtors. As stated by IMF, one reason why Thailand instituted the restructuring of its banks’ NPLs much later than in many other Asian countries was because of the relatively late  establishment of an agency to acquire nonperforming assets. According to IMF, it is difficult to evaluate the progress of TAMC because of insufficient information disclosure, although they do concede that the notional statistics illustrates that TAMC played a progressive role in the restructuring process for NPLs. The purchase of loans by public asset management companies was effective in stimulating a decline in the number of NPLs in Thailand.

Sri Lanka

Sri Lanka has become more of conservative in case of credit disbursement. Credit is disbursed with increasing the provision coverage, which is right now 63% in Sri Lanka. The data reached an all-time high of 15.8 % in December 1999 and a record low of 2.5 % in December 2017. Better governance, legal actions and policy implementations have lowered the NPL ratio rapidly.

Bangladesh and India have a high NPL. But other countries did successfully curb down the NPL. China is a huge economy with a large number of Banks in the country for different purpose. Malaysia and Thailand are almost close to the economy size of Bangladesh. But both the countries have a lower number of banks. Whereas Bangladesh being smaller than those economy, have almost double banks and NPL higher than 10. The economy size of Malaysia and Thailand are almost close to the economy size of Bangladesh, but both the countries have a lower number of banks.

What measures can be taken to improve the NPL scenario in Bangladesh?

To curb down NPL, Bangladesh should initiate some major restructuring:

 The FIs should start restructuring the overall operation by taking measures like increasing collateral, receiving additional legal document, verification and authentication of those legal documents.

 Corporate entities should start some restructuring in some elements like capital structure. Capital structure should be in such way that the firm must invest a certain amount of capital, and besides capital structure of the company, total assets and management of the organization should be under strict regulation.

 To overcome the default of the companies, some provisions like merger and acquisition, realization of disinvestment transaction should be introduced in overall business practice.

Also, some other measures should be taken in a bid to control the growing default culture:

 Additional collateral is required when the value of a loan is increased from previous financing

 According to loan policy, banks have specific limits for specific type of loan, loan officer should not cross that limit

 No government subsidies & financial promotion to the firms who are loan defaulters

 Applying some restrictions on loan defaulters, such as restrictions on establishing new company, purchasing new flat and house, buying car, riding on air plane, staying in five star hotels and limiting the current collateralized and non-collateralized wealth.

 Government should establish AMC’s to settle the non-performing portfolios.

 FIs should be able to recognize the defaulters so that they could be stopped from taking future loan from any other bank.

 The borrowers should be publicly ashamed so that the tendency of willful default of the borrowers decays.

 

Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the respective organization.

(The cover story is developed based on a research paper titled “Exploring the Strategies of Managing Non- Performing Loans (NPLs): An Analytical Revisit of NPL Management in Selected Asian Countries”. The authors of this paper are: Mohammad Omar Faruk, Research & Strategy Division, Bank Asia Ltd., Md. Saiful Islam, Research & Development Department, Mutual Trust Bank Ltd. and Mohammad Motiur Rahman, Service Quality Department, Mutual Trust Bank Ltd.)