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Banking and its Achilles' Heels

by Mohammad Nurunnabi Chowdhury
**8Reasonable lending rate will permit trade and industry to prosper and at the same time should keep banks healthy as well The irresponsible banking made possible so long by a hugely wide interest spread must come to an end as soon as we turn around the present crisis. Let banks work for their survival and living and not hang on to extortionary interest-spread making themselves and the rest of the economy sick.***
BANKS lend their deposi tors' money. This makes their business fragile.
The wisdom of the trade is, therefore, handle with care'. Utmost care is called for on the part of bankers in Judging credit-worthiness of their borrowers. The track-record of a borrower will tell the bank a lot about his ability and willingness to pay The business line on which the loan is sought should tell the rest about his credit.
Conservative commercial banking would not touch longterm lending But that distinction is now fading in modern banking. Commercial banks, entering into the capital market, are undertaking new and bigger risks. This market is. however, another kettle of fish. This new business, therefore, demands fresh new skill and new machinery for success. Our banks appear to have rushed headlong without building the required Infrastructure.
Banks in Bangladesh are known to have been failing in the very basic task of credit-rating of their borrowers. Unchecked rent-seeking by a group of bankers makes nonsense of credit-rating. Creditworthy people may he denied loans and unworthy people can have all they ask for. Their cunningness creates papers in the name of collaterals in place of real security. These deals are in bankers' books not because they did not know how but because they wanted them there. Collaterals are Indeed poor substitute for genuine security of a loanee based on his good track-record and a sound bankable project. When properties are of dubious titles or these are valued sky-high, there is no use blaming the defaults. Default has been built in..
It is said that existing law of the land cannot adequately deal with bank defaults. It needs some explaining in what ways our laws are Inadequate. Our criminal code have been effectively dealing with frauds and forgeries for ages. There is no reason why they should be failing with bank frauds san forgeries. It is. of course, true that law is no respecter of any particular class, bankers or non-bankers. Reluctance to go to criminal courts cannot be explained by inadequacy of law. As to realisation of arrears by civil suits, value or title cannot be made to flow into worthless or scantily-valued properties. We have time-tested laws to deal with titles and ownership. Default by bankers in what they take as collaterals can never be remedied by recourse to law. Here banks will have to set their house in order. Law may. however, has to be updated particularly for quick disposal of cases. Accusing finger at law merely diverts attention. It merely deludes and stores the problem for a future explosion.
The reckless banking in the country has created a huge pile of Tk 13000 crore outstanding loans. The classified loans have increased from Tk 9942 crore in 1965 to Tk 11054 crore in 1996. These are non-performing in various degrees. They account for an unbelievably high figtire of 32 per cent of loan portfolios of banks against the norm of about 3 per cent or so in mature economies of the world. Take
another measure of the colossal stock of classified loans. It exceeded the tax revenue of the government in 1995 fiscal year. One measure of the magnitude of the problem is that six large Grivate commercial banks have inded themselves with bad debts of 73 per cent of their total classified loans. That is not all. Many banks have failed to make required provisions under rules.
The mess in private commercial banking has been caused primarily by insider loans to directors of banks in their own names and in fictitious names. It is not understood what the central bank of the country was doing while these banks were being plundered. It is the duty of the central bank supervisors to promptly spot the huge irregular loans and bring the culprits, both bankers and non-bankers. to book. Commercial banks hold depositors' money in trust and the central bank is guarantor of that trust. Mismanagement of that trust money makes the present impasses appear to be a collusion of bankers, both central and commercial.
What insider loans did to private banks, policy loans did to state owned banks. These banks were lending to terminally sick public enterprises and were piling up defaults after defaults. They could be directed to lend couple of hundred crores to hide merchants whose defaults exceeded a thousand crore. It is again these state
owned banks who could be directed to lend to share market even when it was in complete disarray. Politicians tend to take these banks as their fiefs. They think, they can direct them as they please.
Marco-economic volatility played a key role in banking crisis of some developing countries. Bangladesh has been enjoying macro-economic stability so long. That is now showing signs of weakness. Consumer prices are becoming uneasy, currency reserve is falling, budget deficit is rising and Taka has become volatile — it has undergone devaluation seven times in course of less than one year. The Mexican bank debacle, sparked off by Peso devaluation, cost a rescue operation of $38 Million, major portion of which came from the USA. Mexico was lucky in its geo-political situation. Bangladesh will have none of that luck. Further weakness in it, therefore, its as bad for the economy as for the fragile banking system of the country.
Our commercial banks have gradually moved into non-con-ventional areas of lending, attendant with high risks. Real estate business has lured many into this apparently lucrative area. The danger is that it is characterised by sharp swing of boom and accession. Recession can give a nasty Jolt to its values and can thus make its lenders reel. Over-exposure to real estate has made even some Japanese banks sick. Thai and
Philipino banks are now in a tight comer for the same reason. The extent of exposure of our banks to real estate is not known. Caution is. however, called for. The catastrophic run of the stock market should cause stock-related assets of banks to suffer miserably. It did leave the country's foreign currency reserve poorer.
One wonders how could commercial banks continue to do business as usual with a huge stock of bad debts. The answer lies in interest-spread practice of our banks. The difference between deposit and lending rates — interest spread — can hide serious ailment by absorbing large losses for the time being Our commercial banks pay a paltry 6 per cent for deposit and charge a hefty 16 per cent for Ioans. That gives an interestspread of 12 per cent against the norm of 1 to 3 per cent in mature economies. The Japanese prime rate of interest was 1.63 per cent on April 9. 1997 and the money market rate was 0.44 per cent indicating a spread of a little over 1 per cent. The pre vailing rates in Germany on the same day were 4.75 per cent and 3.25 per cent — a spread of 1.5 per cent and in the USA these rates were 8.50 per cent and 5.69 per cent — a spread of 2.81 per cent. What is most surprising is that our banks should be charging less for their loans because our wages, rent and standard of equipment are Incomparably lower.
Modern banking is all about
reducing interest rate on loans Banks in industrially advanced countries do not confine their income to interest earning alone. They are developing themselves as deliverer of fl nanclal services. Our trade and industry have been suffering under the crushing burden of extordionary interest rate. Our libera) trade regime has opened up our market to the foreign trading interest without any barrier Without comparable rate of interest they are sub jected to unfair competition. It need not be so Keeping in view the prevailing rate of inflation the deposit rate may stay at 6 per cent but the lending must also be brought down to a single digit figure. That makes an economic as much as a financial sense. Reasonable lending rate will permit trade and industry to prosper and at the same time should keep banks healthy as well. The irresponsible banking made possible so long by a hugely wide interest spread must come to an end as soon as we turn around the present crisis. Let banks work for their survival and living and not hang on to extortionary interest-spread making themselves and the rest of the economy sick. Banks are the life-line of the economy. It is the circulatory system of the economy. It nourishes and sustains the economy. The ardent prayer of millions of bank depositors and the people at large is that the central bank of the country must wake up from slumber and firmly deal with the looming bank crisis and take all the necessary hard decisions to arrest the dangerous drift to catastrophy.
The author is a former Sec retary to the government and a former Ambassador.