NPL creates credit crunch situation

One of the most important tasks of banks today is follow-up and supervision of the credit provided. A large number of borrowers from different sectors of the economy are being financed and consequently the supervision of bank credit becomes more challenging than ever before. The main objectives of follow-up and supervision of bank credit are: (i) to ensure that the bank credit is utilised for the purpose it has been sanctioned for, (ii) to keep a close watch on borrower's activities and particularly note if the project has been started in time, (iii) to evaluate the performance of the unit in terms of production, sales, profit etc, and also to see if the borrower is in line with the original plan, (iv) to appreciate the management capability, (v) to get information on external factors like economic situation, government policies etc, and (vi) to detect indications of sickness at an early stage in order to take corrective actions to avoid sickness.
One of the main reasons behind the default culture of our banking industry is lack of supervision and monitoring which is called post-disbursement monitoring. Loan repayments should be monitored and action should be taken for any delay. A financial institution should develop a portfolio information system that enables management to conduct analysis of portfolio quality, determine trends in the portfolio over time, and identify possible causes of delinquency.
The disposal of suit/cases is very important as our legal system is not known for early disposal of cases. The government may find the way in co-ordination with the central bank for speedy disposal of cases like opening of more court, keeping provision for disposal time period of cases in Money Loan Act.  Banks may allow recovery agencies for recovering classified loans.
The existing legal framework for recovery of loans encompasses the Money Loan Court Act, 1993, the Public Demands Recovery Act, 1913, the Bankruptcy Act, 1997 and some other laws. It is reported about 73 per cent cases out of total suits filed have been settled under Money Loan Court in 2012.
According to Bangladesh Bank (BB)'s latest data as on  September 30, 2016, total provision shortfall of money amounted to Tk.43.81 billion which is lower than Tk.44.45 billion in June 2016. As per the rules of Central Bank, the scheduled banks are bound to keep a certain amount of money from their profits as provision against their classified loans to avoid risks in doing business and keep maintaining capital base. But a good number of banks are facing shortfall due to deficit in their financial capital resulting from high classified loans and low level of profitability from operation. The government recapitalised an amount of Tk.12 billion in 2015 although the bank's capital shortfall was around Tk. 20 billion as of December 2015, according to Bangladesh Bank's Diagnostic Review Report (DRR). The capital shortfall of the banks increased to Tk.24.23 billion as of September 2016, the latest report observed.
According to the latest Bangladesh Bank data, banks' total write-offs of unrecoverable loans increased to Tk.423,219.6 million as of June 30, 2016 while the figure was Tk.414,372.7 million as of March 31, 2016. Write-offs in the banking sector usually increase when the defaulted loans in the industry maintain an upward trend. The amount of write-off loans was Tk.412,374.4 million as of December 31, 2015. The defaulted loans and the write-off loans together in the banking sector stood at Tk.1,056,975.5 million at the end of the first half (January-June) of 2016. Banks are allowed to write off loans when those become defaulted loans of bad or loss category subject to filing of recovery suit and 100 per cent provision build up.
Non-performing loans and performance efficiency are inversely related. So, increase in NPL hampers the performing loan. In most cases, it occurs when there is an adverse selection. Averse selection is asymmetric information problem that occurs before the transaction. For example: big risk takers or outright crooks might be the most eager to take out a loan because they know that they are unlikely to pay it back. As adverse selection increases the chances that a loan might become a bad loan risk, lender might decide not to make any loans, even though there are good credit risks in the marketplace.
NPL creates the credit crunch situation when banks are compelled to ration loan disbursement and new credit commitments. Banks treat loan as an asset. They expect return from it. If loans become NPLs then banks have lack of fund to issue loan according to their commitment or at their previous interest rates. Clients have to pay more and loans may be defaulted. Credit crunch also increases the frequency of NPL.
Slow cash inflow always leaves a negative impact on a business. When NPLs rise, interest income drops, but the cost of fund and the cost of management remain unchanged. The existing lending rate has to be increased to cover the costs and increased rate of interest makes it harder for a new borrower to return bank money. Eventually rate of investment will be lower.  NPL affects opening of LC (Letter of Credit) because international importers always prefer healthy condition of the exporter's bank and as such low rate of LCs affects banks' earnings.
When the level of classified loans outstrips an agreed point which the banks cannot accept, it affects bank's re-balancing actions.
After the global recession, banks globally are now re-assessing their business profiles against Basel III capital requirements and other strategic priorities. European banks are shoring up their capital levels amid prospects of stricter regulatory oversight.
The writer is with Prime Bank. The views expressed here are of the writer's own, and not necessarily of the
organization he represents.
 mjamil11974@gmail.com