Despite numerous initiatives taken by the Bangladesh Bank and different commercial banks, the recovery from delinquent customers is not very satisfactory. Private lending growth rate has been experiencing an upward trend for many years. It gives a clear indication that the unprecedented GDP growth rate of Bangladesh is fuelled by the private sector.
On the other hand, the provision on account of substandard lending in the financial sector is also increasing. An exceptional business friendly environment had been prevailing in Bangladesh during the last decade just before the outbreak of the Covid-19. So, the upward trend of classified loans cannot be justified with such overall macroeconomic stability.
The government has a mindset to motivate private entrepreneurs all the way by resorting to the role of a facilitator. In order to keep them concentrated into business, the government took various initiatives to regularise the default loans under easy terms and conditions.
Immediately after the outbreak of the Covid-19, a massive stimulus package of more than Tk1 trillion was declared by the government. Such a step is the result of the recent upward trend of private credit growth. It is undoubted that a good number of entrepreneurs will be able to place the business on the right track with the help of this fund while some will abuse this opportunity the same as before. As always, the good borrowers will be forced to indirectly pay the price.
Hence, instead of identifying the root causes of slow business growth for any particular industry, extending back-to-back incentives to all commercial entrepreneurs "across the board" cannot solve the ultimate problem. Rather, it is posing a serious threat for the financial sector of the country.
Apart from the so called "corruption" with borrowed fund, there are some underlying prime reasons which have been causing high amount of substandard loans:
Excessive dependence of borrowed fund
In Bangladesh, in most cases, land and civil infrastructure owned by the entrepreneurs is one of the most critical components of the project proposal submitted with the lender for industrial loan. If the debt equity ratio is not matched as required by the lender, land and civil infrastructure is overvalued to raise the equity part.
As a result, the entrepreneur is not injecting cash directly to implement the project. Generally, lenders supply funds to purchase machineries and working capital. Since, the cash stake of promoters is not at optimum level, the sense of ownership of the promoters is not very strong.
Diversion of funds
Disbursed funds may be diverted by the promoters to acquire "unproductive" assets which are not connected with the projects. As a consequence, from the first day, the project cannot operate at a satisfactory level due to a lack of adequate working capital. Moreover, the project needs to service the debt obtained on the entire period though a part of it is diverted outside. It results in an acute mismatch between cash inflow and outflow which makes the project financially weak.
Unplanned business diversification
With an objective to tap the growth opportunity of the economy and reduce the dependency on existing business, entrepreneurs are encouraged to create new ventures. Without building capacity (skilled people, technology etc) in the new industry, any potential risk therein will surely affect the continuity of core business. As a result, the investment of lenders in both diversified and core businesses are at risk.
Irrational cost of fund
Until April 2020, the cost of funds of banks had been in double digits while it's now capped at nine percent. However, if the penal interest and compounding factor are taken into account, effective rate of interest hits the roof.
Again, the lending rate of Non-Bank Financial Institution (NBFI) is continuing at double digits because of their high deposit rate. In a competitive environment, it is very unlikely that a commercial organisation can generate an adequate amount of surplus funds to meet the commitment of lenders.
Long term assets funded by mid term loan
Some projects require longer time (sometimes its 2-3 years) to start generating adequate cash to pay lender's dues while lenders generally do not allow more than one year as a moratorium period.
After the moratorium, if the borrower cannot generate adequate cash from the business, it settles the dues of lenders taking loan from another lender. This vulnerable solution is very risky for existing lenders, new lenders and the borrower itself. It forces the borrower to enter into the "vicious cycle of debt".
Lending without adequate immovable collateral
It is true that the ethical practice of the borrower is the main driving force for the lender to get the money back. Despite that, adequate immovable collateral in addition to personal or corporate guarantee plays an important role to recover the dues from delinquent customers.
In many cases, lenders may give waivers to borrowers from pledging an adequate amount of immovable collateral taking the image of the borrower into consideration. This kind of "gesture" deters borrowers from taking a serious role in paying the money back to the lender.
Flaws in project proposal
To convince the lender, financial projections are prepared with utmost "optimistic" mindset. The risk factors associated with macro economy are not always addressed. The proposed production facility estimated in the project report is much higher than the actual production in reality.
This triggers "idle capacity cost" in reality which makes the product noncompetitive in the market. Lenders do not carry out due diligence exercises engaging industry experts particularly on the non-monetary assumptions stated in the project proposal. Such approach sometimes guides lenders to invest funds in unviable projects.
Historical financial statement
Submitted financial statements based on fiddled numbers cannot exhibit the exact historical performance of a continuing organisation. If the lender invests funds taking such financial reports into consideration, it is almost sure that the fund will trigger future pain for the lender. Hence, the lender should arrange an independent financial audit engaging one of their panel auditors.
Many large conglomerates do not feel the importance of the implementation of corporate governance to ensure proper utilisation of funds and keeping commitment with the lenders. Different opinions of multiple board members of the borrower can also give rise to the misuse of funds.
A class of organisations do not maintain a proper accounting system to evaluate the performance of the entity. This practice is an obstacle for both the borrower and lender to get an alarm bell before the disaster takes place.
Disconnection of borrower with the lender
As soon as the fund is disbursed, the lender only thinks about the recovery of principal and profit/ interest. They never deal with the "how" part meaning how the cash will be generated to pay the dues of the lender. If there is any flaw in the operation of the business, return of the fund will be far-fetched.
During the last three decades, the defaulters were offered numerous opportunities to regularise their loans and streamline their business. In the last 12 years, interest amounting to Tk145 billion was written off to reduce the burden of the borrowers. Yet a few of those conglomerates could manage to fix their problems.
The government has allowed borrowers to skip payment to lenders from January 2020 to December 2020 to deal with the slow growth in the economy resulting from the Covid-19. To secure the investments, lenders are reluctant in disbursing new funds except anything under a stimulus package during this pandemic.
Instead of avoiding the core function of business i.e. lending, lenders should always be very cautious in selecting right customers to invest. Continuous monitoring on the business is the only remedy for the lender to avoid substandard loans.
Monthly reporting on core activities, monitoring industry movements, competencies of the top management team of the borrower, auditing the report by independent auditors etc are critical factors for the lenders to safeguard their assets.
The central bank, being the policy setter, should design a comprehensive guideline so that lenders take the role of "financial partner" of the borrowers instead of considering the borrower as a "vehicle of income".
Mohammad Zahid Hossain is a fellow member of ICAB, and an associate member of ICAEW. You can reach him at [email protected]
Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard.