The inability of the commercial banks to force borrowers to repay loans is the central problem of the Bangladesh financial system. This is nothing new. It goes back to the beginning of Bangladesh. The banking system in 1990 was dominated by the government-owned banks. Neither the government-owned banks nor the handful of private banks recognised in their accounts the level of non-performing loans (NPL). Essentially, everyone pretended that the loans were going to be repaid sooner or later, being confident that collateral would cover the loan. This was an impossible position to maintain. Forfiture of collateral was impossibly difficult, undermining confidence that a loan would be repaid.
When the Financial Sector Reform Programme (FSRP) was designed in 1989-90 the high level of NPLs was the most important issue to tackle. The level of NPLs is a matter of definition; the FSRP brought a much stronger set of rules, less than international standards, but more demanding than the pre-FSRP rules. The assessment concluded there were very high levels of NPLs in the state-owned banks (greater than 30 per cent) while private banks were much better but still too high (less than 10 per cent).
Seven steps were taken to move away from this unviable condition:
1. Legislation established the Money Loan Courts requiring resolution of disputes over loans and enforcing repayment within six months from a case being filed by a bank.
2. A Bankruptcy Act was passed and Bankruptcy Courts established. The intention of this law was to open up court-controlled restructuring of companies that were unable to repay loans, while keeping the company in existence.
3. A Credit Information Bureau (CIB) was established to inform banks of the payment record of prospective borrowers.
4. A well-defined system of loan classification was put into effect requiring the banks to recognise non-performing loans and to take provisions [i.e. put aside money] to cover potential loan losses. In addition, the practice of counting uncollected interest on NPLs as income of the bank was stopped.
5. The banks were required to maintain sufficient capital according to international standards. This would force banks with lots of bad loans to increase their capital or to reduce their lending.
6. Restrictions were put in place to limit strategic ownership of a person to one bank and to limit family ownership of any particular bank; if a person could gain control of two banks he could pass his loans back and forth between the two banks borrowing more and more while the loan was never classified and never repaid.
7. Banks were required to carry out a credit risk assessment prior to making a loan. This process was designed to assist the bank staff to recognise when a potential borrower was likely to default.
The FSRP planners believed that these seven steps would improve the sanctioning of loans and strengthen the role of the judicial system in forcing repayment of defaulting loans. For some years there was some success in the private banks, where Bangladesh Bank (BB) had significant power to enforce the rules. Unfortunately the state-owned banks continued their behaviour and little progress was made in improving their lending record. As time passed most of the actions of the FSRP have become moribund and the society returned to its habit of avoidance of repaying loans.
The Money Loan Courts have failed to handle the loan disputes. From the start these courts were unable to meet the time limits established to dispose of cases. Average disposal time (Filing to judgement) is greater than five years. Delays are lengthening and case backlog grows. There has been insufficient attention to training and technical issues to make these courts work efficiently. There have been insufficient judges, insufficient technical support for the judges, and no identification of methods of enforcing judgement. The money loan courts have contributed little to loan recovery and their success is mostly for smaller loans.
The Bankruptcy Law was still-born. No one was interested in making it work. Rather than rescheduling loans after serious changes were made in the structure of the enterprise, rescheduling meant, "do not bother us about this". While there were all sorts of rules related to rescheduling, forbearance was common. Bankruptcy courts should help to take troubled companies and turn them into profitable enterprises through restructuring the finances of the company while making the owners bear much of the burden of loss. Alas, this has proved impossible.
The CIB worked quite well, but defaulting companies turned to the courts to block the report of such default. This was pretty silly since the lending banks knew the real situation. Despite this the banks lent money to existing, known defaulters. Banks cannot be compelled to lend; in a sound bank there is always reason to deny credit to a doubtful borrower. Still quite effective, the influence of the CIB to deny access to credit by defaulters is steadily declining.
The new system of loan classification and provisioning had a powerful, positive effect on private banks most of whom tried to improve the standards of their lending. Recognising that the state-owned banks would never change BB quietly limited their lending. Gradually the banking system got better and better. Unfortunately almost from the beginning of the new system efforts were made to weaken the classification rules. The central bank even allows banks to not recognise the provisions that they are supposed to make. Several private banks do not take the provisions as a cost! The classification and provisioning system has gradually weakened and Bangladesh Bank has been unable to stop the rot!
The capital adequacy requirement means nothing if a bank can avoid recognising the required provisions. None of the state-owned banks and several of the private banks could meet their capital adequacy unless these institutions were permitted to not meet provisions requirements. Even more unfortunate, when banks meet their capital requirements by ignoring the provision costs the bank is allowed to pay dividends to the owners! A commercial bank must pay its bills, i.e., recognise its provisions, before it can give out dividends.
The central bank has been unable to implement rules about bank ownership. What Americans call "strawmen" pop up as shareholders of banks but such persons are under the control of others. Now big groups owning part of more than one can pass their loans from one bank to another, "pillow pushing" they call it. The central bank should be able to stop it, should it wish to do so.
Finally, the credit risk assessments are not taken seriously in most banks. Just fill it in to show everything is fine. So the young banker is corrupted from the start and trained to participate in the culture of making loans unlikely to be repaid.
The result of all this is an NPL ratio significantly higher than officially recorded. Informed opinion suggests private banks have 10-15 per cent NPL and state-owned banks 30-35 per cent. These ratios have been rising to the levels pre-FSRP actions.
All of this breaks down to two observations:
1. The courts are not successful in supporting the banks to recover loans. Both the Money Loan Courts and the Bankruptcy Courts are of limited effectiveness as instruments for loan collection.
2. With inadequate support from the courts, increasingly the banks no longer make the effort to recover their loans. Instead it is much more comfortable to let the defaulters take the depositor's money!
To improve the increasingly fragile banking system the most important step is to strengthen the role of the courts in loan recovery. Not simple to do, but possible under the leadership of the Chief Justice and the Governor.
The consequence is obvious: Unless loans are repaid then the network of regulations enforced by Bangladesh Bank will essentially close down lending and reduce the value of the banks on the stock market. Private sector investment will stagnate or decline and economic growth will slow.
Dr Forrest Cookson is an economist.
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