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Non-performing loans: macro and micro realities

Ehsan Khasru
Time has come to look over the financial seaor market operators before they move to a state of standstill. Without a holistic approach to address issues, especially the NPL (nonperforming loans), the consequences will be a "limp financial system”, bringing unimaginable miseries in every segment of our economy. Fitch, an international rating agency, in a report released in 2014 on Bangladesh, pinpointed two major concerns namely political uncertainty and financial seaor risks. Fitch rating on Bangladesh is BB-, a country ceiling with stable outlook. It should be mentioned here that negligence by al) governments in the past in regard to streamlining the financial system in the country has given birth to a limping financial sector since the independence. Fiduciary responsibility and legal consequences in reality did never come especially in regard to extension of loans and advances for why the credit extension process mostly served wrong distribution channels on an ongoing basis. Whatever legal framework is available is not strong enough to stop the repetitive nature of the financial offences.
The effective legal proteaion to the lenders against sour credits and corporate governance were conveniently kept weak. No government gave full attention to the effective reformation of the legal system to make the evils accountable. The banks as a result functioned to serve the vested interest group causing people's money evaporate from the productive system. Moral degradations, unethical praaices, negligence to due diligence and distina corporate governance issues in the absence of deteaable accountability process have caused loose underwriting standards and inadequate monitoring of the portfolio by the banks.
The NPL which we see is now a 40-year-old baby. Since the last 5/6 years banks and financial institutions have started seeing the NPL pregnancy pain in respea of declining capital adequacy and
other efficiency ratios. The NPL ratio is even worse and horrifying in the case of stress scenario under internal capital adequacy process. Some banks are reportedly experiencing provisions and/or capital shortfall. For ages NPL severity was hiding by way of under representation of the reality by the financial institutions, until the current management of Bangladesh Bank has strengthened their compliance benchmarks and brought automated reporting system. Bangladesh Bank audit and inspection process has taken a modern forensic approach.
The Fitch rating admitted the faa that the country's financial sector is now meeting multiple international benchmarks including establishment of effective internal controls and compliance and full automation of financial reporting in banks. State-owned banks need to catch up this race. The central bank is determined to bring good corporate governance even at the expense of the board and the management. Recently the central bank governor also felt the necessity of their own transparency and to deal with the issues by an ombudsman. Lots of positive steps and control measures were taken by the central bank and a Jot are yet to be done. The question that still remains unanswered is, without a proper stable political framework at the macro level, will Bangladesh Bank end up with the right framework of credit monitoring and control and compliances in the long run? Therefore, the country should guarantee a stable legal framework that various economic aaors can reliably count on.
The gross non-performing loans (CNPL) ratio of the financial sector increased to 10.5 percent in the first quarter of the current year but that of state-owned banks rose 21.9 percent. Unless GNPL sees a downward trend, the financial seaor or the whole country for that matter will see a meltdown. In extremity, how is this tiny economy going to sustain the severity of meltdown if it happens at all?
It is good to know that our financial seaor is highly resilient.
Previously it sustained impact from global meltdown, Asian crisis and other frequent natural and man-made calamities. Bangladesh constantly registered more than 6 percent growth despite much negativity.
But the question is without struaural reforms, how long can we boast our historical performances or financial sector resilience? How many times the loan rescheduling rules could be relaxed to help businesses affeaed by political unrest? Recent information indicated that banks until June 2014 rescheduled Tk 18,552 aore under relaxed rules. This is huge.
Keeping the macro aspects of NPL aeation aside, we have to additionally understand the char-aaeristics of financial institutions that are likely to create excessive NPL. This understanding is necessary, at the micro level, for the bankers to formulate pragmatic lending strategies to run a manageable risk portfolio with longterm missions and visions.
Excessive NPLs are generally the characteristics that include: (a) influence by external forces which lead to the aeation of risky and marginal loans, (b) weak underwriting standards, (c) inadequate internal monitoring system, (d) high interest rates, (e) large scale decentralisation of the lending decisions, (f) pursuit of profitability at the expense of prudence, (g) mismatch between assets and liabilities, and (h) severe corporate governance issues.
The institutions having these charaaeristics will see the prominent loan deteriorating warning signals. Most financial institutions are already seeing these signals. The governance culture is that either the management is under-representing the realities or not able to recognise the amber sign before the red signal comes in. The amber light reflects the abnormal growth in the loan portfolio, high migration rates to the NPL portfolio, liquidity problems, growing discontent among customers, above or below average return from lending operations, above average requests for excess/need for constant restruc-
turing of facilities, market rumors, market panic and so on.
In the conclusion, struaural reforms at least in the management of NPL are a need of the time. The central bank has to be given full autonomy over state-controlled financial institutions. At the micro level, nonperforming asset management companies will separately deal with NPLs of state-owned banks. Within every bank there are two separate streams namely good bank (good portfolio) and bad bank (bad portfolio). A clear demarcation line in a bank has to be drawn between the good and bad banks. The bad bank is recommended to be managed by a non-performing asset management company or by the concept of a subsidiary for remedial management. Non traceable loans will have to have forensic audit to dig into the origination. For the good portfolio and for the new loan creation the corporate charaaeristics of likely NPL (as discussed above) need to be removed. Bangladesh Bank is thinking of creating a taskforce to deal with the NPL and lay down new rules for establishing accountability. That could be an option but the remedial management through subsidiary could even be a better option.
The central bank has already developed a live automated reporting system (dash board) by the banks for monitoring purposes. Bangladesh Bank mentioned that the dash board eventually will be directly conneaed with core banking systems which will obviously bring standardisation and revolution In the monitoring and control of the banks. Individual banks need to freeze lending when NPL registers beyond a certain level, create rehabilitation unit (remedial management subsidiary) for marginal accounts with well-defined work-out-strategies, move from decentralisation to centralisation and finally remove decisionmaking process for NPLs from the lenders.
The writer is a former managing director of Prime Bank Ltd.