Loan Write-Off debate : What is it all about ? The real problems are elsewhere ?

Introduction

Bangladesh Bank (BB) has recently made some revisions in its Loan Write-Off Policy (BRPD Circular No. 01 dated 06 February 2019). Such a policy was first formulated & circulated by BB, after 32 years of independence of Bangladesh, in 2003 (BRPD Circular No. 02 dated 13 January 2003) , that was partially modified by BRPD Circular No. 01 dated 29 December 2004 and BRPD Circular No. 13 dated 07 November 2013.

First classification & provisioning policy was formulated after 18 years of independence of Bangladesh

It may be mentioned that , with the assistance of the World Bank , the first classification and provisioning policy was formulated by BB, after 18 years of independence of Bangladesh, in 1989 (BCD Circular No. 34 dated 16 November,1989).That means during first two decades of our independence , our central bank ( Bangladesh Bank ) or commercial bankers did not think , there is something called credit risk that is inherent in banking/lending business ; therefore, loans are required to be classified according to their risk status and that interest , on principal loan - that itself is doubtful of recovery, should not be recognized as income until realized in cash and that principal amounts, when become doubtful of recovery ,beyond any reasonable doubt , should be adequately provided for.

Best practice must ensure presentation of true & fair view of the financial results and position

Because altogether that is the best practice in international banking and because that is essential for  presentation of true & fair view of the financial results and position of a bank by ensuring that users of financial statements of a banking company are not misled by overstatement of assets,profits, and equity; and understatement of risks,costs and liabilities. 

The main changes between previous policy and current policy

Previous policy

• Loans classified as BAD/LOSS can be written off any time, provided 100% provision has been made and legal suit has been filed in the court. However, if 100% provision is not maintained, still the loan, otherwise eligible, can be written off by debiting current year’s income for the deficit in provision.
• There were some exceptions in the above conditions like :

- On case to case basis , such eligible loans can be written off without filing lawsuit , with the prior permission of BB ( 2004) ;

- Up to Taka 50,000 loans, otherwise eligible, may be written off without filing lawsuit in the court (2013).

Current policy

• Loans classified as BAD/LOSS for continuous three years can be written off  , provided  lawsuit has been filed in the court. However, if sufficient provision is not maintained, still the loans, otherwise eligible, can be written off by debiting current year’s income for the deficit in the provision.
• There are some exceptions in the above conditions like :

- Any loan ,irrespective of its classification status , recoverable from a deceased  individual or sole trading entity owned by a deceased individual may be written off without filing lawsuit ( if not eligible for suit under Money Loan Court Act 2003). However, whether there is any earning successor to that deceased person that should be taken into account.

- If initiative for selling mortgaged property (if any) and if recovery efforts from guarantors are failed then the loan in question would be considered eligible for writing off.

-  Up to Taka 200,000 loan, otherwise eligible, may be written off without filing lawsuit in the court.

• No loan can be partially written off
•  No loan can be written off without approval of the board of directors of the bank.

Conditions in current policy similar to those in the previous policy

•  All out efforts must be continued for recovery of written off loans
• Every bank should have a separate debt collection unit for recovery of such written off loans
•  For expediting the legal process/lawsuit or recovery of written off loans , third party can be engaged
•  Records of written off loans should be maintained in a separate ledger , cumulative amount of such written off loans should be reported in the annual reports of the banks
• The defaulting borrowers, whose loans have been written off, will continue to be treated as defaulters and such loans with its defaulting borrowers should be regularly reported to the Credit Information Bureau (CIB) of BB.

Major differences between previous policy and current policy

•  Earlier loans could be written off any time if it was classified as BAD , 100% provision had been made ( deficit ,if any, could be debited to current year’s income ) and lawsuit had been initiated. However, after 5 years such loan must have been written off without any delay.

Now, any such loan may be written off after being classified as BAD for consecutive three years. Full provision requirement (or debiting current year’s income for deficit) and requirement of filing lawsuit are kept unchanged, excepting in some exceptional cases (deceased individual etc)

•  Earlier, the ceiling for loan eligible for written off without filing lawsuit was Taka 50,000 (2013), now it has been increased to Taka 200,000 (2019) provided other conditions for writing off a loan are fulfilled.

The above-noted two points have been subject of fierce debate by bankers, economists and policymakers.

What should be generally accepted policy or preconditions for writing off a loan?

Any loan can become unrecoverable, in normal course of business ,whatever efficient or effective the credit risk management system may be , because of unforeseen internal and external risks or events which may arise in the future , those are beyond the control of the bank management and because future is always uncertain .

However , other things remaining same, if conflict of interest , related party lending, insider lending and cross lending in disguise can be fully eliminated, loans which are underwritten fully on commercial consideration on arm-length basis, and if, an effective credit risk management system is in place , starting from , screening of any loan proposal , constant surveillance during the period the loan is outstanding and raising red flag immediately as and when warranted to take instant corrective measures, until final recovery of such loan ; the probability of such loans becoming unrecoverable will be significantly less.

If and when after putting all best practice in place, exhausting all options and efforts for recovery of a loan (including but not limited to management efforts at all levels, recovery efforts by third parties, legal measures, out of court settlements, arbitrations etc.), if it appears to the bank management that the probability of recovery of a particular loan, beyond any reasonable doubt, is bleak, then the loan should be written off.

The question is how and when a bank management can reach such a conclusion ?

The argument against writing –off a loan early or too early

•  If , there is a conflict of interest, insider lending , related party lending ( very often in another name ) and cross lending in disguise , where the beneficiary within bank ( directors , management ) may have a vested interest in writing off the loan as soon as possible so that it is taken off the book of the bank and out of sight forever. In that case , it is only serving the interest of the related individual parties within bank (directors, management) , but it is sharply against the interest of the bank – depositors and smaller shareholders ;
•  Assuming that there is no conflict of interest; the concerned people in a bank (management) may have a vested interest in writing off a loan early or too early just to take the loan off the book and out of sight; and sweeping their inefficiency or incompetence or corruption under the carpet. It will go against the interest of the bank, depositors and shareholders.

What are the solutions?

An effective internal control system, separating the duties & responsibilities of the management and board, effective oversight function by internal audit, audit committee of the board as well as external auditors and BB can effectively prevent such malpractice. Particularly the board and its committee must make the management accountable if they themselves have no vested interest in writing off or non-recovery of a particular loan. The point is that effective good governance ensuring transparency and accountability sufficiently overseen by external independent entities like external auditors and BB can prevent such malpractices.

The argument for writing off a loan

•  If above-noted two reasons can be eliminated and, as mentioned earlier, if the, probability of recovery of a particular loan beyond any reasonable doubt, is bleak, then there is no justification to keep that loan on the book and it should be written off forth with.
•  It will clean up the book/balance sheet of unnecessary assets and liabilities ( provisions & interest suspended ) , reduce NPL amount and NPL ratio , but most importantly allow the bank management to focus more on performing loans or NPLs where prospects of recovery ,beyond any reasonable doubt, is significantly better ( for performing loans ) or comparatively better ( for classified loans not yet written off ).

So where is the debate?

• Earlier BAD loan could have been written off ( with some exceptions ) , after making full provision and filing lawsuit , any time before completion of 5 years , but after 5 years it was mandatory to write-off (2003).
•  Now BAD loan can be written off ( with some exceptions ) , after making full provision and filing lawsuit after 3 years of becoming BAD and there is no time limit for mandatory writing off ( 2019) .

So where is the point that the policy for writing off loans has been liberalized? Some people are interpreting the previous policy (2003), as if, eligible loan could not be written off, before it had been classified as bad for 5 years. Though the way it is written in the circular (2003), it can’t be interpreted that way even by the Bangladesh Bank.

Criticism of new write –off policy, right or wrong?

According to newspaper report (The Financial Express – 8 February 2019) Dr Salehuddin Ahmed, former governor of Bangladesh Bank has “lamented the reduction of time limit from five years to three years” (a). Dr Ahmed argued “potential defaulters will benefit from the latest policy relaxation“(b) . He however said  “provisioning cost of the banks will be reduced after the relaxation of the policy “(c ).

None of his claim is right. Let us examine them ,one by one:

(a)   Time limit for writing off bad loans has not been reduced indeed. As mentioned earlier, in 2003 policy, any bad loan, subject to complying with other conditions, could be written off any time after becoming bad, making 100% provision and filing lawsuit , but any such loan must have been written off after five years of becoming bad.

In 2019 policy no such bad loan , subject to complying with other conditions could be written off before continuing as bad for three years ( any time in 2003 policy ) and there is no mandatory time limit for writing off such loan ( five years in 2003 policy ). Therefore, time limit for writing off loans has not been reduced indeed.

(b)  For the sake of debate, it may be said that defaulters between the ranges of Taka 50,000 to 200,000 will benefit from relaxed policy. The banks will be also benefitted here because , in many cases, the legal cost may exceed the ceiling of Taka 200,000 let alone the cost of executive time. Therefore, it does not make any sense to go for legal actions to recover smaller amount of loans.

In other cases, there is no relaxation of write –off policy in 2019 compared to the policy of 2003 along with policies of 2004 and 2013.

Moreover , as per BB regulation , in general , if bank has to continue all recovery efforts including legal measures , such defaulters ( whose loans have been written off ) continue to be reported to CIB and treated as defaulters , then there is no question as to how defaulters can be benefitted from such loan write-off , unless the bank deliberately discontinue actions for recovery of such written off loans for questionable reasons.

(c)   No asset/loan on the balance sheet can be written off without recognizing similar amount off loss/ cost in the income statement. That loss may be recognized gradually or in one go in whatever name, total cost /loss to the bank will be exactly equal to the loan being written off.

As for example, the loan amount is Taka 100 against which there is Taka 20 interest suspense and Taka 80 specific provision. Therefore, the loan is fully (100%) provided and otherwise eligible for writing off. What does it mean? The bank has lost Taka 20 as interest suspense. Assuming original principal was Taka 80, against which full Taka 80 provision has been made, the bank has lost Taka 80 here. Total loss thus stands at Taka 100.

Now assuming that against Taka 100 loan, there is no provision and no interest suspense. Now, it can be written off either by making Taka 100 specific provision or by directly debiting loan-write off account by Taka 100. Whatever may be the name of the account, cost or loss ; the bank has to recognize loss for full amount of Taka 100 in its income statement, it is as simple as that.

A bank can never write off a Taka 100 loan without recognizing equal amount of loss made earlier or at the time of the writing off. Therefore, provisioning cost of the bank will not be reduced at all.

The real problems are elsewhere, about which sufficient discussion & debate is missing.

•  Conflict of interest, insider lending, related party lending in disguise and cross lending in disguise ( by insiders of two banks ), usually in most favorable terms ( interest rate, fee rate,exchange rate, equity requirement, collateral requirement including documentation and credit limits), very often exceedingly crossing generally accepted credit norms,discipline,risks and limits.
•  Ever greening of non-performing loans i.e. restructuring or rescheduling again and again without merit.
• Very slow, inadequate, ineffective legal process and institutions, where no reforms have been made in the recent years.
• Attitude of defaulters that once loans are written off , they are off the hook , that requires to be effectively changed once for all , which requires drastic legal and institutional reforms.
• Attitude of the bank management that written off loans deserve less attention and efforts than normal or classified loans not yet written off.

What are the real issues-urgent, essential and important- for attacking the pervasive default culture in our banking industry?

Eliminating conflict of interest, insider lending,related party lending and cross lending in disguise

If BB really wants to eliminate insider lending,related party lending and cross lending in disguise, then it is not impossible on their part. They have all the information from all the banks. If they create a checklist for doubtful nature and behavior of any bigger loan (size may be determined by BB) then further digging into it and walking- through will eventually reveal everything. This is not a rocket science. With a well defined checklist and training of officials it can be reined in.However, BB alone cannot do that without strong commitment as well as moral and policy supports from GOB.

Right way to reduce NPL or NPL ratio is good governance and effective credit risk management ensuring best practice

Reducing NPLs by recovery of true cash without any window dressing is the real thing , keeping good loans in recoverable condition, beyond any reasonable doubt, in normal course of business is even better. Reducing NPLs by rescheduling and restructuring based on merit ( the restructured and rescheduled loans should be recoverable, beyond any reasonable doubt, as per new repayment schedule) is also acceptable.

Restructuring or rescheduling without merit , without ensuring that future cash flows will be sufficient to service the loan installments throughout the tenure is a recipe for grand failure

In order to artificially reduce NPL ratio , so called rescheduling and restructuring , on whole-sale basis , without merit , may not eventually save the banking sector . The ultimate consequence may be disastrous.Restructuring or rescheduling without merit, without ensuring that future cash flows from the business entity will be matching and sufficient to service the loan installments until the last installment is paid ( as per the new restructured or rescheduled repayment schedule ) , without major repair or replacement and without requiring major fresh funding ; is a recipe for grand failure.

Ever greening , rescheduling and/or restructuring without merit must be stopped

Reducing NPLs by pure window dressing ( ever greening of NPLs without merit ) will not solve the problem. If that option is used then theoretically NPL ratio can be even Zero Percent for ever , like 1st two decades of our Banking Sector ( 1972-1989) ,when there was no classification or provisioning policy in our banking sector.

Deliberately suppressing the size and dimension of default loans is like denying cancer in one’s body

Suppressing amount, size and dimensions of very high and unsustainable Default Loans is like denying cancer in one's body . Whether one having cancer is admitting it or not ; it is growing inside one's body without admission, identification or treatment.After a point of time , it will be irreversible and one day it will kill you without fail . Starting treatment at a later stage , when that very critical point of time is crossed, will produce no results and will not save one's life .

Consequence of un-recognized credit loss arising from poorly managed credit portfolio/credit risk may be bankruptcy

If credit risk is not rightly managed and credit loss already suffered , arising from poorly managed credit portfolio/credit risk, is not properly & timely recognized in the accounts , then, in one fine morning, the bank may become bankrupt ( unable to pay the depositors because assets are not recoverable ), unless bailed out by the government and/or the central bank. Whether the government and/or the central bank will ultimately bail out the bank that will depend on many internal and external factors , some of which may be beyond the control of the government and/or the central bank under the circumstances prevailing at that time.

Real quality of loan and real position of NPL will ultimately matter

The real quality of loan and real position of NPLs will ultimately matter. For some time , somehow everyone can be deceived, until before the position is deteriorating to the extent when the market & depositors will smell a rat and start queuing in bank branches for withdrawing their deposits.We have witnessed such scenario in our banking sector in the recent past, have not we ?

Multilateral agencies , credit rating agencies want to see credibility of financial statements rather than artificially reduced NPL.

The multilateral agencies, international credit rating agencies and foreign correspondents want to see quality & credibility of the financial statements more than artificially reduced NPL.

RBI governors are quitting on policy issues concerning NPL management

RBI governors are quitting one after another ; number one reason is : how to attack the big willful loan defaulters in India. They have left RBI but not compromised or surrendered. Because they strongly believed that , it is their mandate & sacred responsibility to keep the banking sector strong, healthy and solvent on a long term basis so that it can play its vital role in strongly supporting the real sectors of the economy ; and that , artificially reduced default loans may lead to catastrophic consequence.

Rather stringent measures be taken against defaulters including separate High Court bench

BB should rather take stringent measures so that defaulters in general and particularly big & willful defaulters are taken to task instantly and decisively. BB should work out plans with due consultation with bankers how the willful big borrowers should be taken to task. Stringent measures should be taken against defaulting borrowers who are not paying back loan on time with this and that excuse, many of them are willful defaulters . One such measure should be expediting the legal process. Now-a-days, filing writ petition has become fashionable by identified big defaulters. Filing writ petition is a fundamental right given in our constitution; therefore, anyone can do that. However, the matter can be resolved very quickly. BB along with Ministry of Finance (MOF)  should take up the matter with the Honorable Chief Justice of the Supreme Court so that at least a separate dedicated bench(if not more) is established solely to resolve such writ petitions filed by the defaulters. This is highly important considering the contribution of banking companies to national economy and adverse impact of higher non-performing loans on investment, trade ( internal & external ) ,capital formation, employment and GDP growth.

Writ petition by defaulters should be preferably settled within maximum 30 days, because it is 100 times easier to determine by the High Court whether someone is a loan defaulter than determining whether someone is a murderer.

 In any case, resolving a loan default related writ should not usually take more than 30 days. It is hundred times easier to prove whether someone is a loan defaulter or not than proving whether someone is a murderer or not. In the same way money loan court cases should be resolved within maximum 90 days, if necessary existing law should be changed. Diversion of funds should be tried under criminal law. We are talking about Taka 993 billion outstanding default loans on the balance sheets of banks ,that is after writing off Taka 379 billion (net of recovery) . Altogether , the amount of default loans as of September 30, 2018 was Taka 1,372 billion that is 14.6% of total outstanding loan and 6.1% of our GDP.This Taka 1,372 billion default loan does not include restructured & rescheduled loans. It is a very big drain on our national resources and progress that’s why such special legal measures are highly warranted provided BB along with MOF can convince the Supreme Court and the lawmakers.

Similar law necessary like 'The Insolvency and Bankruptcy Code,2016' in India with provision for automatic transfer of defaulting entity to insolvency proceedings if no resolution can be reached within 180 days, with borrowers immediately losing control over the entity.

In this respect, the measures taken by the Reserve Bank of India (RBI) may be mentioned. Based on 'The Insolvency and Bankruptcy Code, 2016' RBI has taken strict measures in India to streamline NPL resolutions. This code is time bound – from the day one when a loan become overdue, Bank may take maximum 180 days time (which may be extended only once for another maximum 90 days) to agree a resolution with the borrowers. If any resolution cannot be reached within maximum 270 ( 180+90) days then automatically the borrower will be transferred to insolvency process that has to be also closed within maximum 90 days ( which may be extended only once for another maximum 45 days). As soon as insolvency process starts borrower will lose all authority and control over the management of the company, everything will be taken care of by professional agencies appointed as per law for this purpose, banking companies will form the board of directors. No injunction can be imposed on such proceedings and if the company or its board has made any transaction within the period of one year preceding the insolvency commencement date, with a bad intention, that transaction will be treated as cancelled. Proceedings under this code have already started in India, now the ball is in the court of lenders, any defaulter will immediately become bankrupt and lose everything.

In Bangladesh incentives including ineffective legal system have been always biased towards defaulters ensuring their full control over the defaulting entity until before case is finally settled that may take years together if not decades.

 In Bangladesh ball has always been in the courts of the borrowers. Legal, political and social systems are designed in a way, it is nearly impossible to get back money from defaulting borrowers, if at all how many years or decades it will take only god knows. In the mean time, the defaulting borrowers will be in the control of the company. Even the actual legal process may be delayed by filing writ petition in the High Court.

BB has to take concrete and effective steps for reforming our legal systems (including outdated money loan court act 2003) and institutions for resolving loan default cases quickly within predetermined time frame and taking the defaulters, particularly the willful defaulters, to task instantly and decisively. Only BB, not the banking companies, can do something about it by convincing the government & the lawmakers and the Supreme Court.RBI is working on this very vital issue on a proactive basis; when one strategy is falling short of target, it is again going for another newer and better strategy to address the issue head on.

Imposing social and legal limitations on willful defaulters 

Willful defaulters should be named and shamed publicly to the extent it is permissible by law, because willful defaulting is a criminal offense, not a civil offence.

A willful default may be defined in the following events

• The borrower has the ability to pay back loan but still not paying ( the borrowing has successfully used the borrowed money and the business is profitable generating sufficient cash flows to service the loans );
•  The borrower has not used the borrowed money fully for the purpose/business/project ( the entity ) it was given by the lender , rather he has diverted away borrowed money fully or partially elsewhere ( where bank has no control ) with a bad intension , that’s why the entity, for which the loan was borrowed ,does not have sufficient business operations and cash flows to service the loans ;
• Assets / machinery of the entity for which the loan was taken and used, have been sold / transferred / removed ,without the knowledge and consent of the lender ,leading to full or partial closure of business operations of the entity . As a result, it can’t generate sufficient cash flows to pay back loans;
• The borrower is operating the entity in a way so that it cannot operate profitably rather the benefit is transferred in another entity owned by the borrower ( related party transactions having conflict of interest ) on which the lender has no control ( buying inputs at a higher price and selling outputs at a lower price).

These are the causes and symptoms of a willful defaulter .

Unintentional default may be defined in the following events

• when the above-noted conditions for becoming willful defaulter do not exist;
• when the borrower has all the good intentions to pay back the loan as per agreement with the lender ;
• when the borrower has diligently used full amount of borrowed money for the purpose/business/project ( the entity ) it was taken ;
• when the borrower has diligently employed all the necessary human and material resources and done everything possible according to the best of his ability , knowledge and expertise to make the entity successful maximizing operation,production/outputs, sales, revenue , profit and cash flows ;

But despite everything , the business has failed for whatever reasons, beyond the borrower's control , and as a result , the entity is not generating sufficient cash flows to pay back the loan and thus the borrower is defaulting . This is when a borrower may be identified as an unintentional defaulter ( have willingness but not ability to payback the loan).

Conclusions

Based on discussions above, it may be concluded that the loan write-off policy itself is not a matter of fierce debate or solution. On standalone basis, it will not change our default culture that much. Rather BB, GOB, economists, playmakers and bankers should sharply concentrate on taking the defaulters ( particularly the willful defaulters ) to task by drastically making legal, institutional, social and cultural reforms , because , defaulters particularly will full big defaulters are , altogether , a very big drain on our national resources; who are draining out ( and also smuggling out of the country) economic benefits ( tens of billions of Taka ) created by millions of hardworking common people like farmers, industrial workers and wage earners.