Reducing non-performing loans of banks

In 2014, the banking sector in the country saw increased volumes of classified loans, also called non-performing loans (NPLs). According to the Bangladesh Bank (BB), during Quarter 3 (Q3), the share of classified loans in the total outstanding loans of the banking system rose to 11.60 per cent from 10.75 per cent in the previous quarter. It was 10.45 per cent in the January-March period in this calendar year. The volume of classified loans was 10.03 per cent of the total outstanding loans of the banks at the end of the year 2012, and the amount of classified loans stood at 6.12 per cent of the banks' total outstanding loans in December, 2011.
Practically, the banking sector witnessed much improvement in terms of asset quality during the last five years. Available data on 'Gross NPL to Total Loans and Advances' in the last five years (2009-2013) indicates notable improvement compared to the 2004-2008 period. However, the status of the banks in terms of NPLs in the banking sector in 2014 is a bit different. Though enforcement of the tighter loan classification norms was a factor, the increase in the volume of NPLs during 2014 might be mainly due to the 'hangover' of scams in late 2011 and early 2012 and also because of the difficulties businesses faced in repaying loans following political uncertainties and unrest in 2013.
We are aware of the fact that our banking sector saw a number of unethical practices and irregularities in late 2011 and early 2012. The frequency and magnitude of such fraudulent activities inflicted a huge burden on the banking sector and left adverse impact on public confidence and reputation of the banking sector. It is generally recognised that such types of unscrupulous activities cannot take place without the active collaboration or passive approval coming from a section of bankers. These were definitely the cases of failure of internal control and compliance on the part of the banks concerned. It is well- recognised that no degree of supervision can prevent the irregularities altogether -- it can only reduce the probabilities. It is recognised that when an irregularity is identified by a supervisory authority, then it becomes too late to prevent that. Steps can only be taken for preventing future scams. That makes the internal control system the most effective mechanism to prevent any sort of banking irregularities.
The Bangladesh economy suffered heavy losses during the prolonged political unrest in the second half of 2013.  That was no less than a 'short-term economic and business crisis'. Cost, borne by the country beset with shutdowns, blockades and strikes, was over US$ 6.7 billion, which is equivalent to 4.7 per cent of the country's GDP (gross domestic product), as estimated by the Centre for Policy Dialogue (CPD).  The ready-made garment (RMG) sector was the hardest hit. Overseas buyers' orders dropped due to a political impasse and frequent labour unrest jolted a number of factories. Total cost of the turbulence must be much above the estimated figure beyond any doubt. Business houses, especially small enterprises, were badly affected by the unrest. In such circumstances, the BB discussed business situation of the country with the top executives of banks, business houses, and other stakeholders and offered an opportunity to reschedule loans at less-than-required down payment and an extended time for instalment payment to support the business houses affected by the prolonged political unrest. In addition to that, in order to cushion the impact of the disruptions done to businesses, the BB (Bangladesh Bank) undertook important policy steps to broaden the scope of the Export Development Fund and to reduce the borrowing costs of genuine borrowers facing cash-flow difficulties. Banks were requested to be particularly aware of the difficulties facing small and medium enterprises (SMEs). That was a timely and logical step on the part of the central bank to encourage and support business houses of the country. And it is very usual to demonstrate such a flexibility to support the economy in a difficult situation. A substantial amount of loans was de-classified in December last year following relaxation of the loan-rescheduling policy.  It is unfortunate that some unscrupulous business houses misused the flexibility and took unethical advantage with the support of their respective banks. However, a large number of businesses and banks have thus been benefited.
During the recent years, the BB attempted several times to guide banks to consolidate control over the growing NPLs. Terming the current 11.60 per cent classified or non-performing loans in the banking sector a 'matter of concern', the BB governor has of late directed different banks to take effective measures to bring down the percentage by December.
Pointing fingers at the 'supervisory failure' is not very uncommon on identification of any occurrence of fund misappropriation or increase in the NPLs in the banking sector. It is well-recognised that the 'banks' supervisor' or the central bank can play a remarkable role in preventing banking irregularities. None can deny the role and responsibility of the central bank in ensuring safety and soundness of banks.
However, the supervisory authority alone cannot prevent NPLs and irregularities.  The central bank must get enough support of the internal control mechanisms of the banks.  
In recent years, notable changes have taken place in the regulatory and supervisory arrangement of the BB. The BB's supervision capacity has been strengthened through greater automation of  information circulating in the new e-monitoring system. The BB's initiative to implement Basel II framework is a praiseworthy one as it has improved the risk absorption capacity of the banks. There was a remarkable increase in the 'Provisioning Maintenance Ratio' in last five years (2009-2013) as compared to the period (2004-2008). As a whole, the performance of all banks improved. It is basically the outcome of the formulation and enforcement of stringent provisioning requirements by the BB in recent years.
There might be some apparent 'negative impact' on the classified loans of banks due to enforcement of tighter classification norms. Enforcement of such international standards would bring positive impact in the future. However, we need more effective internal control and compliance systems and improved corporate governance practices in the banks. In fact, the existing supervisory arrangement with a supportive and positive approach of the stakeholders would be able to deliver. Most importantly, if the  business environment remains stable in 2015, it would help in bringing down the classified loans to a reasonable and expected level.

Dr. Shah Md. Ahsan Habib is Professor and Director (Training), BIBM. ahsan@bibm.org.bd