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1 February, 2018 00:00 00 AM

Managing non performing loan

Credit leads to an increase in spending, thus increasing income levels in the economy
Masihul Huq Chowdhury
Managing non performing loan

Commercial banks in Bangladesh have a serious problem with non-performing loans. During the first nine months of the last year (2017) loan defaults, according to Bangladesh Bank, increased by Tk181.35 billion. Cumulative loan defaults stood at Tk803.07 billion. If the written-off amount of Tk450.00 billion is added to this, the actual loan default stood at TK1253.07 billion. Shares of banks recorded fall in the stock market because of media reports on loan default. Centre for Policy Dialogue (CPD) has identified the year 2017 as year of banking scam. ‘The year 2017 will be remembered as year of banking scam,’ said CPD distinguished fellow Debapriya Bhattacharya while addressing a press briefing on the half year review of the country’s economic situation at Cirdap Auditorium in the city. The local think-tank arranged the briefing to present its observations of the latest state of Bangladesh economy, reports the UNB.

Credit is the most important part of the economy. Ray Dalio, founder of the investment firm Bridgewater Associates, describes it as a transaction between a lender and a borrower, in which the borrower promises to pay back the money in the future along with interest. Credit leads to an increase in spending, thus increasing income levels in the economy. This in turn leads to higher GDP (gross domestic product) and thereby faster productivity growth. If credit is used to purchase productive resources, it helps in economic growth and adds to income. Credit further leads to the creation of debt cycles.

Economic cycles are broken down into four primary phases: early-, mid-, late-cycle, and recession. While business cycles are repetitive in nature, their lengths are difficult to predict. The early expansionary cycle is characterized by positive economic growth, declining unemployment, and rising inflation. This usually follows a recession, so it is a move from negative GDP growth to positive GDP growth. Backed by expansionary monetary policy and low interest rates, credit markets see liquidity as demand for credit and consumer spending start to grow. The banking industry performs extraordinarily during an economy’s expansion. An expansionary cycle is characterised by increased demand for loans and bank services and increased consumer spending. These factors help to boost banks’ earnings.

Nonperforming assets typically refer to loans that have problems getting paid on time or getting paid at all. It is a classification commonly used by financial institutions to designate loans that are unpaid for at least 90 days, have more than 90 days' worth of interest delayed or refinanced or have no expectation of payments continuing. Knowing the disadvantages of nonperforming assets can help you avoid ending up as a lender or borrower of this type of loan.

Interest Income is the first account that gets hit whenever an asset is declared nonperforming. Lending companies such as banks are primarily in the business of earning income from interest paid by borrowers. A loan that has fallen into the nonperforming asset category has not yielded interest for at least 90 days. Any decrease in interest payments will translate into a decrease in net income. A company's income level falls as the amount of nonperforming assets climbs.

The principal, or money used by banks to finance loans, comes largely from the bank's depositors. Banks borrow the money deposited by account holders and loan it to their customers. It is imperative for the bank to recover the money, because it's not the bank's money in the first place. When a borrower defaults on loan payments, the bank is unable to recover the principal. Unrecoverable principal must be replaced by the bank to keep its depositors' funds intact.

Companies react to high levels of nonperforming assets by tightening credit policies. Unrecoverable income and a decrease in interest collections translate into less cash flow. With an increase in nonperforming assets and with less cash floating around, lending companies tend to resort to tighter credit policies. This outcome can slow down economic growth, because some businesses won't be able to obtain a loan.

Nonperforming assets can be used as indicators of a lender's ability to manage its loan portfolio efficiently. The efficiency of lending companies in recovering their principal and earning interest can be measured by comparing their nonperforming assets ratio against those of peer companies. Dividing the amount of nonperforming assets by the total gross loans will yield this ratio. A lending company's efficiency rating deteriorates as the ratio increases.

A non performing loan , or NPL, is a loan that is in default  or close to being in default. Many loans become non-performing after being in default for 90 days, but this can depend on the contract terms. According to IMF, “".

Generally NPL problems are resolved in two ways:

Centralisation – This happens when all the concerned parties including the banks, regulators and government get together to find solutions. This generally takes the form of a central organisation/agency such as an Asset Management Company.

Decentralisation – This approach involves steps taken by the affected banks. The decentralised approach is common for bad loans arising from bad lending. In this approach, the banks are left alone to manage their own bad loans by giving them incentives, legislative powers, or special accounting or fiscal advantages

Many companies see a business opportunity in buying NPL's. Buying NPL's from financial institutions with a discount, can be a lucrative business.  Companies pay from 1% to 80% of the total loan and become the legal owner (creditor). The discount depends on the age of the loan, secured/ unsecured, age debtor, personal/ commercial debt, area of residence, etc.

Worldwide, the most common and successful approach towards NPL management is the establishment of Asset Management Companies (AMC). These companies use public or bank funds to remove NPLs from the bank books. For example, the Korea Asset Management Corporation purchased as much as 80% of bad loans at market rate following the Asian crises. Now, there are several proactive measures that are being implemented:

•     Corporate Governance

•     Better credit information to cut down on fresh NPLs

•     Prudential Supervision

•     Efficient, capable management

•     Well developed capital markets that can offer the mechanism and liquidity required to write off bad loans

The other way is to spin the bank in two parts, Good Bank and Bad Bank. McKinsey outlined four basic models for bad banks in 2009. These included:

•     An on-balance-sheet guarantee (often a government guarantee), which the bank uses to protect part of its portfolio against losses.

•     A special purpose entity where  the bank transfers its bad assets to another organization (again, typically backed by the government).

•    A more transparent internal restructuring, in which the bank creates a separate unit to hold the bad assets. This solution is not able to fully isolate the bank from risk.

•     A bad bank spinoff, where the bank creates a new, independent bank to hold the bad assets, fully isolating the original entity from the specific risk.

A well-known example of a bad bank was Grant Street National Bank. This institution was created in 1988 in order to house the bad assets of Mellon Bank. The financial crisis of 2008 revived interest in the bad bank solution, as managers at some of the world's largest institutions contemplated segregating their nonperforming assets.

bad debt recovery is business debt from a loan, credit line or accounts receivable that is recovered either in whole or in part after it has been written off or classified as a bad debt. Because it generally generates a loss when it is written off, a bad debt recovery usually produces income. In accounting, the bad debt recovery credits the allowance for bad debts or bad debt reserve categories and reduces the accounts receivable category in the books.

The issues which make the recovery of non performing loans are

•     Lack of any standard valuation methodology whereby financial institutions can set up resources for losses arising from NPL resolution.

•     Pressure on banks and financial institutions to understate their NPLs given the social, economic and political repercussions.

•     Unwillingness of banks to sell NPLs because of the costs associated with such an exercise, which could add to the NPL losses. This in turn could hurt their capital adequacy.

•     Issues of NPL jurisdiction

The impact of nonperforming loan in the economy of any country bears more denting impact on the socio economy of the country more than inflation. While the country is in the trajectory of economic boom along with all the social indicators on positive note, the non performing loans are denting in a very bad way. This March, Bangladesh will become member of developing country from least developed country. This is the right time to work cohesively in order to curb down on the default


The writer, a banker by profession, has worked both in local and overseas market with various foreign and local banks in different positions



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Published by the Editor on behalf of Independent Publications Limited at Media Printers, 446/H, Tejgaon I/A, Dhaka-1215.
Editorial, News & Commercial Offices : Beximco Media Complex, 149-150 Tejgaon I/A, Dhaka-1208, Bangladesh. GPO Box No. 934, Dhaka-1000.

Editor : M. Shamsur Rahman
Published by the Editor on behalf of Independent Publications Limited at Media Printers, 446/H, Tejgaon I/A, Dhaka-1215.
Editorial, News & Commercial Offices : Beximco Media Complex, 149-150 Tejgaon I/A, Dhaka-1208, Bangladesh. GPO Box No. 934, Dhaka-1000.

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