BB's new roadmap to curb NPL: Another 'looks good on paper' strategy?

Bangladesh Bank (BB) announced a new plan to reduce non-performing loans (NPL) to less than 8% by June 2026. Such an ambitious roadmap is welcome. But the initiative's implementation is what will determine its success. 

BB aims to take down the NPL of state commercial banks to 10% and private banks below 5% by 30 June 2026. BB has eased the loan write-off policy, empowering banks to speed up the process within a two-year timeframe instead of the previous three years. 

All this may look good on paper, but many of such initiatives have been introduced earlier and they fail to materialise. Doubts have justifiably been raised about how much the roadmap will be followed. 

There are not enough incentives for a bank to ensure good governance to reduce NPL, and since the root cause is still not being treated, it will be hard to eliminate or reduce NPL. 

"NPL occurs in the absence of good governance. This should be ensured first," said Dr Salehuddin Ahmed, former governor of the Bangladesh Bank, adding "BB is trying to achieve ambitious goals; it will be difficult."

The step to relax the loan write-off policy is expected to contribute to a significant reduction in NPLs of Tk43,300 crore, or 2.76%, by 30 June 2026. This may not translate to an effective recovery of the loans; it may only clear the banks' balance sheet. 

Dr Salehuddin pointed this out: "When you allow banks to speed up the process of write-off loans from three years to two years, you are just making it easier for them to show less NPL. This contradicts the BB goal of tightening the grip on NPL. Such contradiction can also be seen when the BB prints more money yet introduces contractionary monetary policy." 

"When you do this, you allow the disease to persist while erasing the symptoms. There is no point in doing that, other than showing a hefty amount of bad loans gone from the balance sheets." 

Default loans in the banking industry were Tk1,550,000 crore at the end of September last year, accounting for about 10% of total outstanding loans. The banking sector's gross NPL ratio was 9.93% at the end of September 2023. The NPL ratio of state banks was 21.7% of their outstanding loans, while the ratio stood at 7.04% for private banks.  

Getting it down to 10% and 5%, respectively, within two years, is a Herculean task, and given the track record in recent times, scepticism abounds. Perhaps the most worrying concern should be whether the BB can enforce its decisions on banks. 

We have seen five Shariah-based banks go scot-free and their management has not taken any flak whatsoever. Such instances do not look good nor bring confidence in the commitment and capability of the central bank. 

Dr Salehuddin holds the weak institutions of the country responsible for such inability. 

"Our banks are weak, and our institutions are weak. The roadmap has good recommendations and targets, but the implementation will be hard because of the weakness of our institutions. Unless this is solved, the roadmap will go nowhere." 

It is not like Bangladesh cannot handle NPL management, as historically, Bangladesh has had a good record of well-managed NPLs. After increasing steadily from 26.09% in 1990 to a peak of 41.11% in 1999, the ratio of NPLs to total loans fell to 31.49% in 2000, 22.1% in 2003 and 13.55% in 2005. 

The ratio hit a record low in 2011 at 6.1%, but not for the best reasons. This happened mostly due to written-off loans, provisioning and a sharp decline in new bad debt. That is why it rose again in 2012 when it became 10.0%, and the NPL rose to 9.7% at the end of December 2014 from 8.9% at the end of December 2013. 

Then, it again declined slightly, to 8.8% in 2015, 9.2% in 2016, and 9.3% in 2017. Then it continued to rise to 10.3% in 2018. Then it began to decrease to 9.32% in 2019 and 7.66% in 2020. 

Then, as the economy began recovering from Covid-19 shocks, NPLs saw a new surge. In 2021, it increased to 7.9%. At the end of September, non-performing loans reached a record high of Tk1.34 trillion, or 9.36% of all outstanding loans in the banking industry. 

"BB should take lessons from the previous NPL resolving cases. BB has resolved such cases since the 1970s with the help of experts, commissions and policymakers," said Dr Salehuddin, 

Muhammad A Rumee Ali, former Deputy Governor of Bangladesh Bank and former Chief Executive Officer of Standard Chartered Bank, lauded the roadmap but raised some concerns regarding its implementation.

"While the plan to tackle NPLs is praiseworthy and has excellent intent, the capital and governance structure of the industry and the socio-economic factors stand in the way of implementing such a plan." 

He thinks the pre-condition involved in this step is hard to implement. "The plan allows write-offs of loans earlier, which is a globally accepted practice. However, the problem lies in the fact that write-offs are allowed only if 100% provision has been made against the particular bad loan." 

"Individual bad loans are often not adequately provisioned. Thus, the effect is that the asset is overvalued. Eventually, writing off these bad debts will be a difficult task."

Having 100% provisions to write-off loans will have two-fold problems. Firstly, most banks do not have 100% provision. Even if the BB instructs the banks to do it, they will not be able to. They would need excess capital, whereas most of the banks actually have a capital shortage. 

Another obstacle is the fact that if banks have to make 100% provisioning for the write-offs, this will significantly reduce the profits of the banks, and the shareholders will not be too supportive. There can be issues for the banks to pay the dividends. Shareholders are likely to be reluctant, as the money is coming at their expense. 

"Provisioning for bad debts will require large amounts of capital, which most banks don't have or will face difficulties raising; resulting in banks moving towards unsustainability," Rumee Ali added. 

Aligned with the guidelines outlined in the International Monetary Fund's (IMF) first review report on the $4.7 billion loan package, Bangladesh Bank's roadmap encompasses the establishment of an asset management company in the private sector. This is a commendable step, but not sufficient. 

Rumee Ali pointed out the necessity of having the whole regulatory and legal atmosphere alongside the asset management company.  

"An asset management company cannot operate in isolation. It has to be part of an ecosystem, which includes the creation of laws, institutions, regulations, systems and processes that will make it work." 

Dr Salehuddin emphasised the implementation of the targets set by the roadmap. 

"Historically, we have been successful because the policies were implemented. However, one of the biggest reasons for the NPL crisis becoming so dire is the lack of implementation. In the last 10-15 years, the problems were not addressed at all, and now they have accumulated and created this crisis." 

"If not implemented, the roadmap will be just like our budget—full of good, ambitious targets but we are unable to complete them. Also, there are political and bureaucratic influences. Only if they don't meddle with the roadmap can the goals be met." 

Rumee Ali also focused on implementation. "A comprehensive approach needs to be taken to find out the financial, legal and institutional issues and resolve them systemically, so that the system itself has checks and balances to effectively stop the growth of NPLs." 

"Bangladesh Bank should also, on a priority basis, focus on preventing new bad debts. It is a must to demonstrate to our global stakeholders our intention to create higher level governance. There are some persisting infrastructural and institutional issues that need to be fixed as well." 

In the end, it all comes down to commitment and implementation. BB needs to make sure the banks are abiding by the regulations and roadmap. The banks that act accordingly should be rewarded, and the ones that will not oblige need to face disciplinary action. Otherwise, nothing will work.

A roadmap is a long-term plan, so it would be unwise to expect a quick result. However, unless it is strictly followed, the roadmap will bite the dust and the NPL crisis will not be resolved.