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How to rein in “wilful defaulters” and eradicate the curse of non-performing loans
My readers must have by now become sick of hearing about the big loan defaulters in Bangladesh and the scandals involving the Farmer’s Bank (now Padma Bank), BASIC Bank, Sonali/Hallmark, Janata, Prime, and a motley of other shady characters including some leading industrialists of the country.
However, the wounds created by the non-performing loans (NPL) fester—they not only affect the health of the economy but also have a crippling effect on legitimate loan-seekers. It is now high time for all stakeholders to get on the case of the loan defaulters in a serious manner and stop extending a lifeline to them for the umpteenth time and neuter the spread of this cancer on our body economic.
Bangladesh Bank (BB) has over time flip-flopped on NPLs and recently announced a moratorium on loan payments until September 30, 2020 which implied that such borrowers will not be in default. Now that it’s October it is believed that this moratorium will be extended.
“It is a temporary relief—the negative situation will come back in a very dreadful way,” said Ahsan H Mansur, executive director of the Policy Research Institute. As a long-term solution, a number of policy measures is in order. First of all, corporate governance should be strengthened and careful due diligence followed in lending decisions by banks. Secondly, in line with the Chapter 11 protocol followed in the USA, the existing Bankruptcy Act, 1997 of Bangladesh, a legal framework for dealing with NPLs should be enforced. Thirdly, there has to be rigorous enforcement of the present banking rules and regulations including the stipulation of secured collaterals to mitigate the risks associated with loans. Finally, authorities could also consider establishing a national asset management corporation (AMC) like the Republic of Korea’s KAMCO or Malaysia’s Danaharta to take over NPLs from ailing banks.
Study after study conducted around the globe with multi-country data show that NPL administration is a policy gone awry and creates and fosters a situation known as “moral hazards”. In economics, moral hazard occurs when an entity has an incentive to increase its exposure to risk because it does not bear the full costs of that risk. For example, when a business is aware that its loans will be written off or its default will not result in any consequences, it may take on higher risk or decide not to repay loans if it knows that the government or others will pay the associated costs. In the language of economics, the cost-benefit ratio of complying (i.e. paying back the loan) is higher than the cost-benefit ratio of non-compliance.
Every business owner and policymaker I have spoken with on this matter is unanimous about the environment that “forgiveness of loans” has created. Let it be said that the problem of “wilful defaulters” is not limited to Bangladesh but is a phenomenon that is prevalent in many countries. Unfortunately, in Bangladesh there is no specific law for legal action against wilful defaulters.
I looked up the protocols followed in other countries to characterise or classify defaulters. Since India is coming to terms with a high NPL ratio comparable to Bangladesh, I looked up the approach taken by the Reserve Bank of India (RBI) to flag “wilful defaulters”. These are: ability to pay, misallocation, diversion of funds, and sale of collaterals.
Interestingly all the four yardsticks apply to the defaulters in Bangladesh. In many other countries including the USA, some of the above actions by a borrower would be considered “money laundering”, which is a criminal offence. In the case of Bangladesh, borrowers are known to transfer the borrowed money to accounts overseas.
For purposes of comparison, in the USA, during the last two decades, the average value of NPL as a percentage of all bank loans was 2.56 percent with a minimum of 0.91 percent in 2018 and a maximum of 4.96 percent in 2009. The latest value from 2018 is 0.91 percent. In Bangladesh, on the other hand, from 2011 to 2019, there has been a steady rise in the volume of NPL and, according to the latest estimate, classified loans had crossed the one trillion mark by March 2019 and has been hovering near 10 percent.
We have witnessed some positive developments recently. As of December 2019, loans disbursed by the banks stood at over Tk 10.11 trillion, and the amount of default loan was Tk 943.31 billion, or 9.32 percent of the total credit, down from 10.30 from the previous year. However, the 41 private banks together had defaulted loans amounting to Tk 44,174 crore, up 16 percent from a year earlier.
The World Bank tracks country level governance using scales for corruption, regulator quality, government effectiveness and rule of law. Newly collected data on non-performing loan (NPL) in more than 190 countries over 27 years clearly supports the proposition that growing wilful defaults are significantly impacted by the low quality of country-level governance.
Wilful defaulters are a unique breed who borrow and forget to return the item. Economists are increasingly zeroing in on the defaulters to identify their characteristics using sophisticated tools, including econometric modelling and publicly available data. Studies done in the USA, Italy, and India reveal that that wilful default is a borrower’s deliberate exploitation of weak governance structure prevailing in the country.
Given the generous policy support afforded to delinquent borrowers in the past, many good borrowers are tempted to default, said Khondkar Ibrahim Khaled, a former deputy governor of the central bank. He urged the BB to crack down on habitual defaulters with fervour, and added, “If these businesses are allowed to get rescheduling facility again, it will be ‘illegal’.”
In an innovative study in Italy, researchers analysed the empirical frequency with which borrowers delay repayment to their lenders. It reveals that firms choose to delay payment to some banks depending on the latter’s health. This selective delay occurs more where legal enforcement of collateral recovery is slow. “Poor enforcement encourages borrowers not to pay when the value of their bank relationship comes into doubt. Selective delays occur even by firms able to pay all lenders. Credit losses in Italy have thus been worsened by the combination of weak banks and weak legal enforcement.”
Japan faced a situation very similar to Bangladesh and an investigation on the widespread practice of banks that lent to otherwise insolvent firms documents the prevalence of “forbearance lending and show its distorting effects on healthy firms that were competing with the impaired firms.”
The impact of the culture of default, rescheduling, and forbearance is crippling to the growth of the economy and healthy practices. According to an earlier World Bank study, bribes collected by bank officials in case of project loans were sometimes linked with local-level project officers. In case of commercial loans, the bankers not only collected bribes amounting to “1.0 percent to 5.0 per cent” of the loan amount but also received occasional gifts, hospitality, or entertainment from clients which is still quite rampant in the state-controlled banks. Working capital loans involved a payment of 1.0 percent to 5.0 percent of the credit to bank managers, employees and trade union leaders. A Transparency International, Bangladesh study points out that 73.5 percent of the respondent households agreed that it was almost impossible to get credit from banks without bribe or influence.
What are the options for Bangladesh? One does not have to look far, but to consider the recommendations made by a six-member committee formed in early 2019 comprising of the Ministry of Finance and BB, which include the formation of an AMC in the private sector, creation of a secondary market for NPLs, setting up a separate data warehouse for NPLs under the existing facilities of the Credit Information Bureau of BB, and a tax rebate facility for traders of the default loans that remain under consideration.
Dr Abdullah Shibli is an economist and currently works in information technology. He is also Senior Research Fellow, International Sustainable Development Institute (ISDI), a think-tank in Boston, USA.