Managing non-performing loans in the banking industry

Default loans in Bangladesh have shown the lowest growth since 2014, increasing only 0.42 percent year-on-year to stand at Tk94,313 crore at the end of 2019, as a result of certain measures taken by the government and a record Tk50,186 crore rescheduled last year, according to central bank data.

Data also shows stagnation in the growth of default loans. Now banks and non-bank financial institutions (NBFIs) need to work on recovering default loans to achieve negative growth in the subsequent years.

Problem loans are an unavoidable consequence of lending. Whenever a loan is given, unforeseen events could arise and make it difficult for the borrower to comply with the terms and conditions of the loan agreement. So, banks need to adopt stringent account action plans and recovery strategies for every single defaulted client. They need to put all out efforts to maximise recovery with consideration for due loss provisions based on actual and expected losses as per Basel regulations.

There are several reasons for such an exacerbating amount of non-performing loans (NPLs) in Bangladesh. Some of these are avoidable – wrong borrower selection and inadequate analysis of income statements, balance sheets, and ratios. Additionally, wrong assessment in loan structuring where banks fail to determine the actual need of financing, working capital assessment and the appropriate loan type, amount, and repayment terms is also an unavoidable reason.

Another vital cause of NPLs is taking collateral which has not been properly evaluated in terms of ownership, value or marketability. Such collateral security leaves a bank unprotected to default loans. In many cases, in the event of foreclosure of the mortgaged asset, the bank finds a much lower value of the asset than the value it had estimated while sanctioning the loan.

This happens due to overvaluation of the assets by bankers or the nominated surveyors. Then, incomplete documentation in lending arrangements leave banks in trouble, stuck with default loans. Furthermore, banks often waive the necessity of taking insurance, which backfires in the event of untoward occurrences such as fires or natural calamities, etc. In some cases, insurance companies even delay or shown reluctance in settling legitimate claims.

On the other hand, there are certain scenarios which are unavoidable – changes in rules and regulations, technology, natural disasters, economic down turns, and any other adverse effects on business.

A major malpractice prevalent among banks is taking over clients from other banks by offering an unrealistic and needlessly higher loan limit. This malpractice in the banking industry is one of the prime causes for a client to go for fund diversion – due to a higher limit, the client is very likely to spend or invest in a way which was not the purpose of the sanctioned loan. This eventually leads to the loan being defaulted.

So, this is a very unhealthy practice of rivalry among banks where they sanction higher limits without considering projected business growth and actual financing needs of the client. Due to this, banks bring problems unto themselves. Although there should be competition among banks, they should not spoil a client by sanctioning unnecessary higher limits just to snatch them.

However, the causes of problem loans should and can be minimised.

Many problem loans could be nurtured at the very beginning while banks can still see the early alerts such as deterioration in cash flow, lower utilisation of limit, sudden drop in sales, longer account receivables or collection period.

To identify and follow up on these early alerts, banks need to monitor every single account on a daily basis, based on the financial indicators. It is really unfortunate that most banks do not take the follow-up process seriously and react to the early signs of a loan becoming problematic. Many problems can be avoided if they are monitored more closely. Banks should have a system for the ongoing administration of their various portfolios that contain credit risk – monitoring the condition of individual credits, including determining the adequacy of provisions and reserves, and monitoring the overall composition and quality of the credit portfolio.

In addition to developing strong monitoring systems, banks need to assess and select the right borrower who has adequate business experience with financing needs, willingness to repay the loan, and is able to provide adequate collateral or security against the sanctioned loan.

Banks also need to consider the option of rescheduling loans for borrowers who are in a period of financial distress. However, banks need to conduct proper due diligence and be certain that the borrower can fulfill the rescheduled terms of the contract. The bank should refrain from rescheduling loans where it has significant doubt regarding the borrower's willingness or ability to repay over the long term.

Even after all out efforts, there will be loans which will no longer be collectable – those should be written off from the balance sheet of the bank from time to time, following write-off policies of the central bank and subject to the approval of their respective board of directors.

After that, banks should repossess properties until the market picks up, and dispose of them into the market quickly and at the best price conforming to the Transfer of Property Act, and all other applicable laws related thereto.

It is mentionable that Section-12(1) of the Money Loan Court Act, 2003, describes that the mortgage, lien or pledged property – moveable or immovable – should be disposed by arranging an auction sale before filing a loan recovery suit.

But in most cases, banks do not take possession of the collateral even though Section-12(5) and (5Ka) of the act specifically describes how a bank can take possession before calling auction, and the concerned district magistrate is legally responsible for repossessing and handing over the collateral to bank. Thus, if Section-12(5) and (5Ka) of the Money Loan Court Act, 2003 is duly followed, then it would be needless to file loan recovery suits, as after extensive and time consuming legal battles, the court will give the decree to recover the loan amount by selling the property which was auctioned previously. The bank then files an execution case to execute the decree – a complicated and time-consuming process.

In most of the cases, banks do not take possession of the mortgaged property while calling the auction, which indeed means banks are interested in filing suits and they call the auction just to fulfill that particular precondition.

Hence, banks need to be more aware of their rights as per the Money Loan Court Act. If a bank takes possession of a mortgaged property before going for auction, then the bank will be benefitted in several ways, i.e., if the property is valuable, then the borrower may become interested to save it by repaying the loan by hook or by crook.

Moreover, bidders will be more interested to buy the property. Banks could also attach other assets of the borrower if it finds major problems in the property, such as problems in ownership while trying to take possession. Overall, a hefty amount of time could be saved and the economy would be boosted up due to faster recovery of non-performing loans if banks properly follow  and implement the aforementioned sections of the of Money Loan Court Act. In addition, there will be significant reduction in the number of cases filed in the court where many loan cases are already pending.

The author is a deputy attorney general of Bangladesh.