Non-performing loans (NPLs) that turn into bad debts are a problem for banking sector everywhere in the world. Bangladesh is no exception.
The banks are now paying more attention to the supervision and management of the risks with a view to reducing the amount of bad debt. In the process of protection in advance before and during the execution of a loan agreement, the banks are evaluating any potential risk that may cause the borrower to default on its loan obligation. As for loans without any guaranty - namely credit loans - when the borrower is an enterprise, firm, or other entity, the bank will prefer a borrower with good credit standing or with a good business relationship with the bank. In some cases, if the bank deems necessary, the borrower will need to prove its qualifications by providing its financial report to the bank before the loan is issued. It is easier for the bank to know the borrower's financial condition if the borrower is an entity, especially a listed company.
Some countries have "Credit Information Assessment Company". The Company provides credit-background investigation services for personal consumption. The report of the company acts as an objective reflection and credit assessment of the past activities of each individual. This report creates a reference for the banks and allows them to make quick decisions on whether to provide credit services. For example, Experian, Equifax and Trans-Union keep records of loans for an estimated 200 million US consumers. Again establishing a "national asset management company" (NAMC) like the Republic of Korea's KAMCO or Malaysia's Danaharta to take over NPLs from ailing banks for repackaging and selling them in the open market at more realistic prices, encourages banks to expedite NPL resolution process.
The company develops cooperative relationships with a number of banks. In the case of a loan involving a guarantor, the bank also faces risks of bad credit, even if the guarantor is provided for security. For example, the borrower and guarantor may conspire to illegally take out a loan, or breach the guaranty agreement by claiming the guarantor to be financially insolvent or bankrupt, to avoid payment. In practice, apart from examining the credit rating of the guarantor as well as examining the credit level of the borrower, the bank also imposes certain restrictions on the guarantor.
The bank may minimise its own risk in the loan agreement by including as many types of legal measures as possible. For instance, in issuing the loan, the bank usually requires the borrower to buy insurance. Mortgage loan insurance mainly includes mortgaged property insurance and life insurance for the borrower as an individual. In the case of property insurance, the bank may exercise its rights over the compensation provided by the insurance company. The loan agreement will generally stipulate that a borrower must provide the bank with a report regarding its assets, business or other financial conditions from time to time.
The agreement may also include a condition that would limit the borrower's ability to conduct certain activities. For example, it is common for the bank to stipulate in a mortgage agreement that the borrower shall not lease the mortgaged property without the bank's consent. If the mortgagee does lease the mortgaged property without consent, then it will be deemed to be in breach of the mortgage agreement. However, in practice, the mortgagee can sometimes secretly lease the mortgaged property to a third party to evade its repayment obligation. It will be difficult for the bank to keep track of every borrower during the term of the agreement. Database of mortgaged property needs to be universally updated by an independent body so that all bank and financial institutions, including any individual, can see the status of the property before lease out/remortgaged to a third party. The borrowers may breach the loan agreement for various reasons, including bad faith, inability, disability, death, liquidation and bankruptcy. The bank may encounter higher risk for loans made to individual borrowers than they would with corporate borrowers. It is difficult for the bank to keep track of an individual borrower's whereabouts once the loans are made.
The bank will have more remedies if the loan is a secured one. For example, according to the guaranty/mortgages regulations, if the bank is not repaid upon expiration of the term of the debt, it may negotiate with the mortgagee to convert the mortgaged property into cash or sell the property for repayment of the loan. If the parties fail to reach an agreement on a sale, the bank can file a claim against the mortgagee in court. It is very inconvenient for the bank to exercise its right through a judicial proceeding because it takes time and extra cost for the lawyers.
The Asian Development Bank (ADB) suggested that a revised bankruptcy act needs to set time-bound procedures to expedite the resolution of cases for settlement. Fair pricing of collaterals through competent accounting firms is essential. Setting up a public asset management company is necessary to expedite the NPL resolution process.
There is no market in Bangladesh for the banks to swap their bad debt by selling non-performing loans. ADB has already promoted an idea of setting up a company like Public Asset Management Company to buy and sell NPL to give relief to banks. However with the development of capacity of banks and non-banking financial institutions (NBFIs), there will increasingly be more ways to sell non-performing loans.
Following steps can be taken to minimise risk of default loan:
* Designing of client selection mechanisms which screen out applicants with a lack of repayment capacity and/or willingness to make repayments.
* Matching of repayment capacity and repayment plans as closely as possible to avoid repayment complications.
* Accepting that default problems generally do not occur because of bad clients but because of bad lending methods.
* Establishing a reporting system which allows for timely monitoring and follow-up action by loan officers.
* Establishing a reporting system which gives up-to-date information about portfolio quality, trends and possible default risk factors.
* Instilling an ethos in the institution that makes late payments unacceptable.
* Establishing an incentive system for on-time repayments. The benefits of paying punctually should clearly exceed the benefits of late repayment.
* Setting up maximum levels for late payments and default as benchmarks for the institution. These levels should be based on a detailed analysis of the costs that arise from late payments and defaults.
* If substantial late payment and default problems prevail, setting up strict but realistic target levels to gradually reduce the amount.
* Rescheduling and restructuring of loans only after a well-defined loan re-assessment procedure has been completed.
Time-bound procedures need to be inserted in laws for Money Loan Courts, fair pricing of collaterals through competent Accounting Firms, a data warehouse for collaterals also needs to be set up to bar borrowers from taking loans from several banks by way of using the same properties as collateral.
It is high time steps were taken to improve our financial sector governance for reducing risk of bad loans.
Dr. Md. Shamsul Arefin is a former Senior Secretary to the government. s22arefin@gmail.com