NPLs: Re-scheduling cannot be an end in itself

Investments and savings are essential preconditions for economic development of a country. As a developing country, Bangladesh is confronted with several problems that are pulling back its expected growth such as culture of bad loans and underdeveloped capital market. The latter mostly depends on the mobilization of the savings and granting credit facilities to investors by commercial banks.
The performance of the financial sector largely depends on the performance of commercial banks. It is well-known that profitability of banks shrinks because of non-performing loans (NPLs). Non-performing loans, which puts a brake on the recycling of banking business, reduce the lending capacity of the banks. Banks always try to create a reserve fund from their income to offset bad debts. Banks need to create high percentage provision to cover high percentage of non-performing loans. All kinds of NPLs reduce the profitability of the banks and banks encounter problem of low capital base which badly affects the banking sector.
Credit facilities are the main product of banks and granting credit is a vitally important decision for the banks because it determines their profitability. Non-performing loans have been a matter of concern for the last few decades.
The banking sector of Bangladesh is characterised by low profitability and insufficient capital base because of high number of banks in the country. Revenue of banks comes from spread (Lending rate-borrowing rate). The weighted average spread between lending and deposit rates offered by the commercial banks, came down to 4.70 per cent in October 2016 from 4.76 per cent in the previous month and 4.80 per cent in August 2016, according to Bangladesh Bank statistics. Our banking sector needs to reduce the interest spread through improving efficiency and profitability instead of slashing interest rates on deposits. Improvement of efficiency depends on better management of balance sheet, both assets and liabilities, including management of off-balance sheet items where main focus should be asset quality as main income of the bank is interest income. The bottom line of the problem lies in the accumulation of high percentage of classified loans over a long period of time. The total amount of NPLs in the banking sector stood at over Tk.6.57 trillion as of September 2016 which was 10.34 per cent of the total outstanding loan of Tk.6.36 trillion, according to Bangladesh Bank. If the written-off loans are added to the NPLs, the amount will come to Tk.11.00 trillion. The problem is most serious for the state-owned commercial banks (SoCBs). The average classified loan for Bangladesh during the period from 1998 to 2015 was 19.95 per cent with a minimum of 5.85 per cent in 2011 and a maximum of 41.1 per cent in 1999. The total classified loan of our banking system at the 3rd quarter end in 2013, 2014, 2015 and 2016 was 8.64, 9.37, 9.29 and 10.34 per cent respectively while the internationally accepted tolerable limit is 2-3 per cent. Moreover, the 'bad' category of classified loans, which is not recoverable, constitutes about 70 per cent of the total NPL. According to World Bank report, globally the average classified loan for 2015 was 7.1 per cent. The highest classified loan was in San Marino: 46.76 per cent and the lowest in Macao: 0.12 per cent. Bangladesh is ranked 31st in the list which is not a tolerable limit for an emerging economy like ours.
If we analyze the NPLs of our banking sector, we find the following facts: (i) reason behind a big chunk of NPLs is political influence and poor governance by banks and regulators; (ii) all aspects of risk management were not considered at the time of loan appraisal; (iii) in most cases imprudent financial decisions by the business concerns, like converting short term fund (working capital) into long term fund (fixed capital) led to stagnation of the company which could not generate required fund to pay installments; (iv) diversion of funds by the business concerns to non-revenue generating assets like land, building and other luxury items; (v) some business concerns escalated the project cost with a motive to borrow excess amount from the bank and the said amount is remitted to other countries as flight of capital; (vi) speculative investment with a view to get higher return mostly in raw materials/trading items like cotton, jute, edible oil, sugar, chemical, coal etc. Here, Banker and customers need to give deep thought to market risks and should engage fund based on calculative market risks; (vii) in most cases higher level of lending rate and fierce competition among the banks make the banks' assets vulnerable; (viii) the sluggish growth of the economy made many businesses unprofitable by making borrowers unable to repay; (ix) frequent changes of government policy made business difficult as policy processes of the government are not that transparent; (x) political turmoil affects the customer business and eventually increases defaulting amount; (xi) several flaws in loan documentation eventually lead to non-realization of money lent. Once a loan is classified, it keeps on being so for a long period of time.
If the invested funds in an economy are not recovered, the recycling of the funds is reduced by the amount of classified loans leading to economic stagnation. NPL affects banks' profitability adversely because of the provision on classified loans, reduces return on investment (ROI), and disturbs the capital adequacy ratio (CAR). It also increases the cost of capital, widens assets and liability imbalance and upsets the economic value additions (EVA) by banks. EVA is equal to the net operating profit minus cost of capital. Banks may face liquidity problem due to high rate of NPLs.
Non-performing loans (NPLs) have always raised concerns among policy makers and the central bank took various measures to reduce the increasing volume of classified loans. Bangladesh Bank adopted various policies, such as, loan re-scheduling facility, introduction of CIB report, waiver of interest etc. to get rid of this excessive volume of NPL. But these measures have so far failed to produce the desired outcome. Although re-scheduling reduces the amount of NPL, it cannot be an end in itself. Loans are rescheduled after the damage is already done.
The writer is with Prime Bank. The views expressed here are of the writer's own, and not necessarily of the organization he represents.
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