Bangladesh Bank moves to harden loan classification rules as per IMF conditions

In response to conditions set by the International Monetary Fund (IMF) as part of a $4.7 billion loan package, the Bangladesh Bank has initiated a cut in the overdue time for term loan, which the central bank fears may increase non-performing loans by around Tk80,000 crore.

Besides, the central bank plans to reduce the write-off time to two years from three years in its efforts to clear the banks' balance sheets of the toxic assets.

Bankers and analysts said these two moves could have a direct negative impact on the financial health of the lending institutions, such as a spike in non-performing loans (NPL) and mandatory requirement of provision and may reduce profitability, but it will help manage the delinquent borrowers.

Presently, if a term loan is not repaid within the fixed expiry date, the unpaid amount is treated as overdue after 180 days and the loan will be categorised as "substandard" after 90 days of overdue.

The IMF wants this time — 180 days + 90 days — to be cut to 90 days per international practices, meaning that an unpaid loan will be treated as "substandard" and a lender must keep aside 25% of that loan as provision.

Similarly, an unpaid loan is "doubtful" and bad before 180 days from the present practice if the BB implements IMF's conditions. The provisioning requirement is 50% for doubtful and 100% for bad loans.

"If the central bank enforces the IMF's conditions, NPLs could surge by at least Tk 80,000 crore," said a senior official from the Bangladesh Bank, citing reports from all scheduled banks.

The findings indicate a potential substantial increase in the banking sector's Non-Performing Loans (NPL), rising significantly from Tk1.55 lakh crore as of September last year. The amount was 9.93% of total outstanding loans.

He said a comprehensive assessment was conducted, collecting data from all banks before the reduction in the overdue time for unpaid loans by 180 days.

The official further said the central bank plans to issue a circular soon to enforce this policy. This change is expected to take effect by March.

The overdue policy earlier was according to international practices, the central bank official said. However, it was changed to the current time frame in June 2019 due to the demands of traders.

"If the central bank adopts the IMF prescription, NPLs could escalate to the range of 16%-18%," said a senior official of a leading private bank. This may pose challenges for many banks to maintain the necessary provisions.

Dr Ahsan H Mansur, executive director of Policy Research Institute (PRI) told The Business Standard Bangladesh should follow international banking practices.

"There were some difficulties initially with the new policy. However, the new defaulters it will make were already defaulters. Before, they were regular on paper."

"He said that the central bank could not make this policy before the elections because then many people would have defaulted. Now is the chance to do it. However, as a result, provisioning of banks will increase greatly," he added.

This should be done for the benefit of the depositors, he said. However, as banks' provisioning increases, profits will decrease. Profits cannot be given to investors.

What bankers say

Emranul Huq, Managing Director and CEO of Dhaka Bank, told The Business Standard that adopting the new overdue period, aligned with international standards, will accurately reflect a bank's true financial health and strengthen loan recovery efforts.

"While the transition may pose initial challenges for banks, it's inevitable that everyone will eventually accept this new policy," he remarked.

Welcoming the move, Syed Mahbubur Rahman, managing director and CEO of Mutual Trust Bank, said the country's banking system should align with international practices.

He noted that many businessmen couldn't pay their debts last year, leading to the conversion of working capital loans (typically with a one-year tenure) into term loans. Consequently, the amount of term loans increased significantly during the overdue period.

"If the overdue time frame shifts from nine months to three months, these loans will fall into the default category," he added.

Credit department heads from two banks told TBS that adopting the international overdue approach makes sense for the banking sector as it encourages more customers to prioritise debt repayment by tightening loan rules.

According to Bangladesh Bank's quarterly report at the end of September 2023, the total loans at the customer level of the country's banks stood at Tk14.25 lakh crores, with about 60% being term loans.

The total loan amount of banks in the industrial sector is Tk5.87 lakh crore, with term loans accounting for Tk2.98 lakh crore, or about 50.78% of total industry sector loans, according to the report.

The central bank also plans to bring in some major changes in the banking sector to contain non-performing loans and address irregularities in the banking sector.

Among them are introducing a detailed policy on willful defaulters and measures against them, necessary legislation to establish Asset Management Company (AMC) in private ownership, and stressed assets cannot be transferred to income without actual interest.

Write-off period like to be slashed

Under current banking policies in Bangladesh, if any loan is classified as bad for three years, banks can write-off those loans. However, the central bank is also planning to reduce the write-off period to two years.

It plans to establish a "write-off recovery unit" in each bank, led by the managing director or chief executive, to facilitate this process. A circular regarding this will be issued soon, said a central bank official.

Dhaka Bank's Emranul Huq said reducing the write-off time is a positive step. "Many banks are financially sound and capable of swift provisioning, enabling faster write-offs. Longer write-off period hinders the process."

As of September 2023, defaulted loans in banks amounted to Tk1.55 lakh crore, with bad/loss loans (18 failed monthly instalments) making up Tk1.36 lakh crore, or 87% of total non-performing loans.

Write-offs totaled Tk67,721 crore by June 2023, up from Tk60,402 crore in June 2022.

A state-run bank's managing director expressed concerns that the new overdue period may lead to more defaulted loans.

Additionally, he anticipates increased demands for loan rescheduling. He also highlighted that banks will see reduced net profits due to the need to provision the same amount as written-off loans, thus decreasing overall profits.

Establishment of Asset Management Company

A committee consisting of representatives of the Ministry of Finance and Bangladesh Bank has completed its initial activities with the aim of enacting the necessary legislation to establish privately led Asset Management Company (AMC), as demanded by the IMF.

A draft law in this regard has been published on the website of the Financial Institutions Department of the Ministry of Finance. In 2024, the process of approving the law will be completed, which will play an effective role in recovering defaulted loans, said the central bank official.

Borrowers got a big relief in 2019 with extension of the overdue period. Then in March 2020, due to the outbreak of Covid, they were relieved from repaying loans for the entire year.

In 2022, borrowers were allowed to pay only 15% of outstanding loans to not be classified as defaulters. The facility was in force till March 2023 with some changes.