The chicken and egg questions of interest rate and default loan

Finance Minister AHM Mostafa Kamal has thrown up an egg-and-chicken question – that high interest rate is pushing up default loans and also high default loans are leading to high interest rate.

Economists, however, do not want to buy the vice-versa theory. To them, it is egg before chicken.

They want to assert that it is a wrong strategy to target interest rate to lower default loans. Rather, default loans are mostly a deliberate delinquent culture in Bangladesh that should be addressed first which would automatically lower interest rate as banks' cost of fund will come down.

So, the latest statement by the finance minister is a lenient view on defaulters and would once again send the struggle to improve the banking system to the back foot.

They also question the efforts so far taken on default loans, saying that these had actually accentuated the non-performing loan crisis.  

"Our finance minister is heading in the wrong direction because causality of high default loan is not high interest rate. Rather, we think that high default loan is the cause of high interest rate," said Ahsan H Mansur, executive director of the Policy Research Institute of Bangladesh (PRI).

"Our suggestion is about how to reduce default loan, but the finance minister is trying to reduce interest rate which is a fundamentally different approach," he said.

He said the special policy of rescheduling loan is not a proper step to reduce default loan rather it will help the influentials to take out money at low cost from the bank.

The one-time large loan restructuring policy of 2015 was the first of the steps to favour defaulters and since then, one after another rule was relaxed by the Bangladesh Bank to facilitate defaulters, including ease of loan classification rule and special loan rescheduling policy at discounted down payment.

Ahsan Mansur said interest rate is low in other countries due to low default loan, also known as loan loss. For instance, in Hong Kong, loan loss is the lowest 0.5 percent when it is about 20 percent in Bangladesh according to the International Monetary Fund (IMF).

In Saudi Arabia, which has the most well-managed financial system, loan loss is 1.4 percent.

"If we cannot change our payment behaviour, no result will come by blaming high interest rate."

"When corporate governance will be established, loan loss will reduce, banks will be well regulated and only then that interest rate will come down automatically," he said.

The practice to favour defaulters started in 2009 through waiving interest, reconstructing and discounting interest rate, causing rise in default loan, said Mohammed Farashuddin, former governor of Bangladesh Bank.

He said interest rate has increased only due to the rise of default loan.

All the measures government has taken so far to reduce default loan will yield the opposite result, he said.

The finance minister said that in December default loan will come down due to implementation of special loan rescheduling policy but it is not the solution. Rather this policy will take the banking sector backward lingering the crisis in future.

The only way to reduce default loan is to strengthen recovery processes and take actions against willful defaulters, he said.

Khondkar Ibrahim Khaled, former deputy governor of the Bangladesh Bank, questions the steps on default loans taken so far, saying relaxing loan classification rule, large loan restructuring and special loan rescheduling policy were to favour defaulters.

"In other countries, defaulters are punished but in Bangladesh, the government encouraged defaulters instead of taking serious action against them causing rise in default loan," he said.

The Asian Development Bank in a report titled Managing Non-Performing Loans in Bangladesh suggested that the government should explore the international best practices in NPL management and the resolution strategies implemented in other countries in Asia and Pacific and Europe.

A look at how other countries dealt with default loans can only show how poorly we dealt with the issue.

Giving instance of the People's Republic of Korea, the ADB said that huge amounts of NPLs piled up in their balance sheet following the 1997 financial crisis. The government cancelled licences and suspended operations of nonviable lending institutions that failed to meet the minimum capital adequacy standard. Because of this aggressive reform, commercial banks had become more transparent and healthier than before and NPL ratio dropped.

But in Bangladesh, one after another sick financial institutions were either recapitalised by the government or were made artificially running. There were once talks of merger of sick banks but that never happened. Padma Bank is the latest example of how a bank ripped to the core was injected with funds to make it artificially survive.

In India, default loan surged to 11.5 percent in 2018. The country brought it down to 9.3 percent in 2019 by implementing the bankruptcy law.

Bangladesh also has a bankruptcy law but it has not been enforced, ever.

To address NPLs and stabilise the financial sector, the government of Thailand moved to shut down bankrupt financial institutions and considered them for merger with others to sharply reduce the number of financial institutions. Besides, the government reformed its insolvency laws.

The NPL in China stemmed from the continued losses at state-owned enterprises and the absence of a commercial credit culture at major financial institutions. To deal with the NPLs and improve the operation performance of banks, China took a set of reforms, including restoring corporate cultures, penalising the defaulters, and imposing restriction on defaulters such as keeping them from travelling by plane and high-speed train, applying for loans and credit card or getting promoted. China blacklisted 6.73 million bank defaulters. 

Nothing of such actions were ever taken in Bangladesh.

The ADB suggested that to ensure that loans do not go bad, corporate governance should be strengthened. Efforts are needed to ensure that loans are made only on commercial considerations instead of political influences.

The authorities should consider that board of directors of state-owned banks should be competent professionals, instead of political considerations.

The ADB also suggested to strengthen the Bankruptcy Act 1997 or enact a bankruptcy and insolvency law.