Overcoming the problem of NPLs

The banking sector in Bangladesh has experienced a huge setback in terms of non-performing loans (NPLs) in the past several years. The NPLs doubled in amount in seven years, from 2011 to 2017.

Primarily, non-performing loans affect the profitability of banks. Studies have shown the negative relationship between the profitability of banks and the rising non-performing loans. It is generally understood that the money which is lost or written off or becomes extremely improbable to collect by the banks put pressure on the liquidity of banks. The banks must find alternative ways to increase their deposits so that they can adjust their lost money deposited by the depositors. This process creates an internal pressure on the banks to generate additional deposits.

An extreme case of NPLs has the danger of creating a 'bank run' situation. In this scenario, the depositors may try to withdraw more money than usual from the banks and consequently put the banks in a situation where they won't be able to meet the required obligations. Here two issues need to be observed: one is the prevailing situation of rising NPLs, and the other is the fear perception of the depositors. If these two conditions precipitate at the same time, then the condition could get worse.

In the simplest notion, the banks collect money from the economy as deposits and use in many ways in investment to create interests and profits for the depositors and themselves. One of the critical issues of the banking sector is that the banks do not hold all the customer deposits available in cash for immediate withdrawal. Instead, banks keep a limited amount of legally admissible money in their collection. Now, if banks become unable to meet customer demands, the situation affects the banks and the economy in general.

Banks, insurance and non-banking financial institutions (NBFIs) pay 40 per cent-42.5 per cent tax to the government. If the NPLs increase, the ability of the banks to pay government tax is reduced, and, in turn, the government loses its ability to spend more for developing the economy.

The high ratio of non-performing loans in banking system leads to a decrease in the CAR (capital adequacy ratio) which is a measure of how much eligible capital a bank has against their risk-weighted assets (RWA). It is expressed as a percentage of a bank's risk-weighted credit exposures and is also known as capital-to-risk-weighted assets ratio (CRAR) of the banks. CAR is a tool that is used to protect the depositor's money and promote financial stability around the world.

The NPL ratio increased from 9.23 per cent to 10.67 per cent in nine months from December 2016 to September 2017. The ratio is still increasing.

These non-performing loans took a huge toll on the profitability of the banks and the economy of Bangladesh. During the last two years, the NPL ratio increased from 8.4 per cent to 10.67 per cent. This is a 27 per cent increase in the NPL ratio to total loans within two years. This is insignificant when we compare the 82.39 per cent increase of NPLs from 2011 to 2017.

Now moving on to a bigger perspective with the other Asian countries, it has been identified that they are also struggling with non-performing loans. Comparing the trends of non-performing loans with other SAARC (South Asian Association for Regional Cooperation) countries reveals an exciting finding. During the last five years, the non-performing loans of Pakistan, the Maldives, and Sri Lanka declined at a noticeable rate compared to the rate of the proclivity of Bangladesh.

The non-performing loan scenario in the member-countries of the OECD (Organisation for Economic Cooperation and Development) is positive. Despite the economic shock in the year 2008, most of the 35 member-countries of OECD have been able to maintain a declining NPL rate for the period of 2011-2016, and in fact, the rate has been declining since the economic shock. Although the NPL ratio of some countries like Austria, Belgium, Greece, Italy, Portugal, Sweden and Turkey has fluctuated, the NPL ratio of these countries in general has declined from 3.66 per cent to 2.90 per cent which is an approximate 21 per cent decrease in NPL in the 5-year period from 2011 to 2016.

Germany, the United Kingdom, and the United States, which are also major exporting partners of Bangladesh, have shown their tremendous success in keeping their non-performing loans at bay. It has been observed from the World Bank data, these three countries have been able to bring down their NPL ratio by 43.33 per cent, 77.50 per cent and 65.70 per cent respectively within the period 2011-2016. In contrast, Bangladesh has faced the consequence of a deadly 82.39 per cent increment in the non-performing loans within that same period.

Now, coming back to the Bangladesh situation, the most urgent issue for the banks in the country is how they should deal with piling up of bad debts in their books. Immediate measures must be taken to prevent and overcome the problem of rising non- performing loans.

Syed Md. Aminul Karim and Md. Ariful Islam are researchers at the Faculty of Business Studies, University of Dhaka.

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