Reducing non-performing loans

Dhaka,  Sun,  24 September 2017
Published : 25 Aug 2017, 22:15:11 | Updated : 25 Aug 2017, 22:15:18

Reducing non-performing loans

Mir Imdadul Haque
Mounting non-performing loans (NPL) harm not only the banking sector but also the national economy as a whole. The authorities fail to recover the loan money from businessmen, many of whom are wilful defaulters. Banks too cannot convert savings into loanable funds as these have to keep aside the amount equivalent to the bad loans as provision, which they cannot invest to maintain stability. As a result, banks' cost of funds shoots up and lending rates get higher. As of April, the accumulated default loans in the economy is Tk 1113.47 billion, which is higher than the development spending last fiscal year. The figure included the written-off loans totaling nearly Tk 400 billion. 

Wilful defaulters take the advantage of legal loopholes. NPLs affect banks' profit margin, scope of business expansion and the plan for job creation, according to experts because economic growth sans jobs is useless. Things are getting worse  day by day as borrowers,  who include some leading corporate houses and also little-known businesses, have been taking away depositors' money, they are found reluctant to return it. 

Prof. Mustafizur Rahman, distinguished fellow at the Centre for Policy Dialogue (CPD), said growing bad loans are impeding further economic growth as banks' lending capacity gets tightened and good clients could not get loans at lower rates.  Bangladesh has one of the highest NPL ratios in the world. Referring to a study conducted by the Bangladesh Institute of Bank Management (BIBM) last year, on an average, NPLs were 12.79 per cent of the total loans in Bangladesh whereas the internationally tolerable limit is 2-3 per cent. 

Many bank risk management officers asked this writer why a loan turns bad. How can we mitigate this? As a risk management officer for about 10 years, this scribe has gathered first-hand knowledge experience in credit risk management with specialised set of skills of risk assessment in large corporate and SME, lease/ term loan financing analysis, financial strength analysis of manufacturing and trading business, financial modeling, feasibility report, forecasting and proper due diligence. 

Based on empirical experience the following can be attributed to wrong financing: 

l Lack of quality collateral. Provision is kept against classified loan (SS, Doubtful, Bad Loan).So, provisioning depends on the outstanding amount and collateral value of mortgaged property and VES (Value of Eligible Security). Taking mortgage or collateral against loans at inflated price has become another big problem for banks that fail to sell mortgaged assets whose market prices are much lower than the loans. 

l Lack of adequate free cash flow. It refers to the income a business generates versus the expenses it takes to run the business analysed over a specific time period, usually two or three years. If the business is a start-up, a monthly cash flow statement for Year 1 has to be prepared. 

l Assessing repayment history. It refers to the timeliness of payments that have been made on previous loans. Today, there are several companies that evaluate commercial credit ratings (such as CRAB, CRISL, WASO, NCR etc.) that are able to provide this kind of history to lenders. Credit rating focuses on the capacity to meet financial commitments susceptible to adverse effects of changes in circumstances and economic conditions. 

l Failure in identifying the key risk elements of sanctioning any loan proposal, foreign currency exchange risk due to poor quality or lack of sufficient knowledge of risk officer. 

l Incapable of assessing properly audited financials: financial risk, business risk and management risk.  It is true and beyond any argument that the credit analysts are reviewers - not verifiers - of the financial statements. Moreover, 360 degree feedback is required; 360 degree feedback is a process that employees receive feedback, often anonymous and confidential, from the people who work around them. These people commonly include the employee's peers and manager. 

l Negligence in digging out the likelihood of fund drainage. 

l Wrong assessment of industry outlook and rivalry. 

l Lack of forecasting of financial toxic wave. 

l Corruption of loan sanctioning concerned officer. 

l Lack of proper understanding of 3 core functions namely risk management function, credit function and monitoring function. 

l Lack of proper monitoring and digging out of gap in due diligence. 

l Wrong understanding of promoter's confidence and experience of the same line of business. A successful borrower instils confidence in the lender by addressing all the lender's concerns on the other Five Cs (Character, Capacity, Collateral, Capital and Condition.) Their loan application sends the message that the company is professional, with an honest reputation, a good credit history, reasonable financial statements, good capitalisation and adequate collateral.  

l Deficiency of industry knowledge of risk officer may backfire. This is an overall evaluation of the general economic climate and the purpose of the loan. Economic conditions specific to the business applying for the loan as well as the overall state of the country's economy factor heavily into a decision to approve a loan. Clearly, if a company is a thriving industry during the time of economic growth, there is more of a chance that the loan will be granted than if the industry is declining and the economy is uncertain. 

l Lack of clear understanding of the purpose of the loan. It's an important factor. If a company plans to invest the loan into business by acquiring assets or expanding its market, there is more of a chance of approval than if it plans to use the fund for more expenses. Typical factors included in this evaluation step include strength and number of competitors, size and attractiveness of the market, dependence on changes in consumer tastes and preferences, customer or supplier concentration, value chain of business, demand-supply gap, seasonality, length of time in business, tangible or intangible product and any relevant social, economic or political forces that could impact the business. 

Moreover, undertaking from clients, Credit Information Bureau (CIB) status of client, guarantors' information, cross-checking of double mortgage and location of property (land demarcation, signboard with total land area and owner's name are also essential. At post-sanction stage recovery is another issue. Regular follow- up and hammering are required from the recovery team before a loan becomes classified.  However, loan rescheduling is necessary (maximum three times as per Bangladesh Bank regulations) but recovery will have to be good. The recovery team should directly manage all sub-standard, doubtful and bad and loss accounts to maximise recovery. 

As such, banks and non-banking financial institutions (NBFIs) should give priority to finance the environment-friendly and environment-sensitive sectors. Environment-friendly sectors may include green finance which is eco-friendly by ensuring sustainable use of resources and not putting any adverse effect on environment. Environment sensitive sectors include those which usually contribute to environmental pollution but such pollution can be mitigated by application of necessary equipment and process e.g. effluent treatment plant, 4 Rs (Reduce, Reuse, Recover and Recycle) programmes and proper waste management, regular assessment on environmental risks and impacts, etc. 

The writer is Head of CRM, FAS Finance & Investment Ltd.

Editor : A.H.M Moazzem Hossain
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