Bangladesh Bank (BB), country's central bank, has recently issued a circular with some directions/guidelines for commercial banks to follow while dealing with non-performing loans (NPLs). The Circular mentions five important points, viz.,-- (I) outstanding NPL can be rescheduled by depositing two per cent down payment, (II) interest rate on rescheduled loan must not exceed 9.0 per cent depending upon the lending bank's cost of fund, (III) maximum term of rescheduled loan is ten years, (IV) there is provision of one time exit facility that able borrowers may avail if they want to pay off entire outstanding non-performing loan within one year, and (V) rescheduled loans will no longer be treated as classified loans, rather will be considered as good loan, so the borrower will be entitled to borrow new loans.
This circular has created mixed reaction among the bankers, economists and the business community. Even the move has been taken to the higher court and the honourable court has stayed the circular's effectiveness for a month. To speak the truth, the present state of the country's NPL has reached such an alarming level that whatever action is taken will invite debate from different quarters. This is a good sign as NPL has become an issue of serious public concern.
I have written innumerable articles on NPL in this newspaper and one of them was a six-part article where I discussed the probable measures and recommendations in the light of many countries' experience in handling NPL.
Some key features of BB's recent circular calls for discussion. It is an undeniable fact that country's NPL has turned into a national problem and all concerned are actively considering to address this situation. In this backdrop, it remains to be seen how far the aforementioned BB circular is a move towards addressing the problem.
RESCHEDULING OF NPL IS VERY OLD PRACTICE: The Circular has extended rescheduling facility of outstanding NPL in the simplest and easiest terms and conditions. Rescheduling of NPL cannot be considered a viable means of resolving the NPL problem because, historically, rescheduling of NPL has not produced any tangible result, rather has worsened the situation in many cases. The practice of rescheduling classified loans, categorised as NPL according to CL (Classification of Loans) report, started since the nineties of last century. From then on, Bangladesh banking sector has been experienced various forms of loan rescheduling such as (I) straight-forward vanilla type rescheduling where loan is repaid at constant instalment payment; (II) ballooning rescheduling where repayment starts with the smallest amount and gradually increases instalment size, and (III) freezing rescheduling where interest remains frozen but principal is paid first etc. However, country's NPL problem has not improved at all. Nevertheless, BB has issued the circular further simplifying the terms and conditions of rescheduling.
AMBIGUOUS FEATURE OF THE CIRCULAR: According to the Circular, outstanding NPL can be rescheduled by depositing only 2.0 per cent of total outstanding non-performing loans. However, the circular does not conspicuously state whether this 2.0 per cent down payment will be equally applicable to all types of NPL -- substandard, doubtful and bad loan, and if so, the measure is faulty as three different types of NPL will receive equal treatment. Further, how this 2.0 per cent down payment will be utilised -- whether principal or interest will be paid first -- has not been clearly spelt out. Maximum term of newly rescheduled loans has been caped for ten years but it does not provide alternative option if instalment size on outstanding amount, prevailing interest rate and maximum ten years term, do not match with borrowers' cash follow generation. Again, it has not been clearly mentioned that whether rescheduled NPL will be taken out of classified loan immediately after rescheduling or some watch period will be allowed to observe the repayment performance of the borrower. BB should have clarified all of these issues. Because of this ambiguity, bankers will face tremendous difficulties in interpreting the Circular in handling NPL. Even there is a possibility of abusing the terms and conditions as influential borrowers may reap maximum benefit from the Circular.
IMPACT OF THE CIRCULAR: Without doing any math, it can be said that this mere two per cent down payment will not reduce the outstanding loan at all, rather may increase the total outstanding loans in many cases. As per current practice, bank cannot take interest accrued on classified loan as income, instead retain it in the separate account what is commonly called suspense account. The classified loan soon after rescheduling is considered good loan and as such interest accrued thereon and retained in the suspense account is immediately taken into bank's income. This unrealised amount of interest is charged on borrower's loan account and then taken into income which technically increases bank's profit at the cost of borrower's loan increase.
The current circular will fuel up this practice. Here is a hypothetical example which may give a clear idea about how adversely this Circular may affect country's NPL situation. Supposing, a borrower has an outstanding NPL of Tk 1.0 billion out of which, Tk 800 million is principal amount and the rest Tk 200 million is interest accrued on the principal amount but not charged and retained in suspense account for future charging. In this situation, the borrower knows his outstanding loan amount is Tk 800 million while interest is Tk 200 million. If the current circular is applied, the said borrower will deposit only Tk 16 million i.e. 2.0 per cent of Tk 800 million as down payment and his entire loan amount will be taken out of classification status and will be treated as good loan. Consequently, the bank will then take the entire interest amount of Tk 200 million from suspense account to income by charging on the borrower's loan amount. As a result, bank's income will increase by Tk 200 million and at the same time, borrower's total outstanding loan will rise to Tk 1.0 billion provided no interest waiver is allowed. From the rescheduling date, the borrower's total outstanding loan will stand at Tk 1.0 billion which was earlier Tk 800 million.
Here is not the end. The unrealised Tk 200 million that will be taken into income will be appropriated among the shareholders and employees of the bank as dividend and as incentive bonus respectably. Once interest is taken into bank's income, it cannot be reversed and therefore, the borrower will have to pay the amount. Needless to say, no conscious borrower should accept this type of rescheduling that eventually increases his loan amount. Besides, influential borrowers will avail the opportunity to borrow new loans because this circular extends this facility.
If the borrower discussed above borrows fresh loan of Tk 100 million, the fallacy is that by deposing only Tk 16 million, he will be receiving Tk 100 million i.e. Tk 84 million more completely ignoring future obligation of repayment. So, in the long run, the borrower's total NPL will rise to Tk 1.10 billion if instalment as per rescheduling terms and condition is not paid. Similarly, the cap on maximum term of 10 years for rescheduling loan may not contribute much towards recovering NPL.
The fundamental principle of loan operation states that instalment size of the loan must be well matched with the borrower's cash flow generation, otherwise no borrower despite having strong intent, will be able to maintain repayment schedule. This principle is applicable for both good and bad loans. However, in case of new loan, there is a scope of changing both loan amount and maximum term in order to determine instalment size in keeping with the borrower's cash flow. Unfortunately, existing loans have less scope because the loan amount is already fixed and therefore, only maximum term can be manoeuvred to determine instalment size matching with the borrower's cash flow. Since this circular has put a maximum cap of ten years for rescheduling loans, whatever the instalment size, irrespective of borrower's cash flow, must be accepted by the borrower. This kind of determining the instalment size which may be inconsistent with borrower's ability must fail and the entire loans will go back to NPL state again.
Nironjan Roy is a banker based in Toronto, Canada. firstname.lastname@example.org
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