Is the loan restructuring narrative credible?

The Bangladesh Bank (BB) has caved in to pressure for extending the loan restructuring facility to large borrowers once again, albeit on a case to case basis. Large loans restructured in 2015 can be rescheduled on lenient terms – low down payments, low interest rates and longer tenure.

When lenders keep postponing repayments, they effectively increase the grant element of loans by reducing the present value of interests and amortisation. This is elementary financial arithmetic. Such privileges to a few large borrowers are provided based on their perceived criticality in the economy.

Production, employment and income will take a hit if these businesses go under. And they will go under if their loans are not rescheduled. In other words, the finances of these businesses are so weak currently that they cannot withstand the burden of servicing their loans even on the previously rescheduled concessional terms.

This is very puzzling. It is incongruent with the narrative on Bangladesh’s recent performance.  Economic growth has accelerated with increase in exports, remittances, public investments and consumption expenditures in both public and private sectors.

In turn, these are attributed to political stability, prudent macroeconomic management, easing of the electricity constraints, increased stock of Bangladeshis working abroad, stable international commodity prices, oil in particular, and the beneficial effects of trade diversion resulting from the US-China tariff escalation.

In 2015, the narrative supporting the case for restructuring relied on political instability, past political based discrimination of certain business groups and global tailwinds which severely constrained the financial solvency of these businesses. How the narrative can be the same now is hard to figure. Why were they not able to benefit financially from the economic stability and progress since 2015?

Yes, it is possible for some to do badly even when the economy is doing well. Just as it is also possible for some to do well when the economy is doing badly. That is the name of the capitalistic game. You gain some, you lose some. You also want to pass on some to sleep better. Corporate risk management practices exist to hedge against idiosyncratic shocks. Any macroeconomic externality argument to bail them out when their risk management fails has to be based on solid evidence.

This is where the puzzle deepens. After all, the economy moved forward at an amazing pace despite their businesses not doing well. Nor is their evidence of downturn in the sectors they are in because the balance sheets of these entities were in red. This makes their criticality argument for bailing out weak and its veracity questionable.

If a business is not doing well under general economic adversities, as was argued in 2015, and alleged to have not done well when those adversities are gone, as was the case since 2015, then how can that business be considered too important to fail from a macroeconomic point of view? 

Of course, there may be noneconomic externalities. The question then is how best to accommodate these interests? Policy concessions of the kind provided to the delinquent borrowers bring with them many moral hazards. When a policy stance responds to pressure groups, the signal transmitted to the market is to invest in ways to build the capacity to exert pressure. No matter what terms and conditions the new policy has to ensure orderly repayments, the game is unlikely to change.

Having been captured, the regulator is no longer seen as working for the general interest, but for the pressure group. Client politics replaces prudential regulation where most or all of the benefits of a regulatory regime go to some, often small, interest while most or all of the costs are borne by many, say, the taxpayers. Regulatory capture conflicts greatly with the notion of “independent” regulatory agencies.

It often evokes a visceral reaction and a fair bit of denialism. Lobbying leading to regulatory capture have real consequences. It weakens the confidence in prudential rules and their non-discriminatory enforcement. This in turn fosters riskier practices and inefficient economic outcomes.

It is therefore important to relieve the regulator from external pressure and find more transparent ways of bailing them out without distorting financial market behaviour. The government has done such bailouts in the past and continues to do so at present.

State-owned enterprises such as Biman, Bangladesh Petroleum Corporation, Bangladesh Power Development Board etc. and the state-owned banks have been provided recapitalisation and loan redemption support through the budget. More recently, we have seen bailing out of a private bank through capital infusions provided by the state-owned banks and non-bank financial institutions.

The government can take over the loans by, say, asking businesses seeking rescheduling to issue equivalent amount of bonds at the same price as the rescheduled loans. The money received from the bond sales can be used to repay the bank loans. That way their accountability will shift to the government through servicing of the bonds.  The public will know exactly how much of their money is used for which businesses and for how long.

There is need for a permanent solution to protect the financial system from the contagion of chronic loan delinquency. The problem of time-inconsistency and credibility of promises made is important to keep in mind here. The challenge emerges from a dynamic game between the regulator and the pressure group where the pressure group is the dominant player and the regulator is the follower.

The pressure group promises to the regulator what it considers to be optimal to get the loan rescheduled. If this promise is believed then, in the next periods, delivery of the promise may not remain optimal because the pressure group knows reneging brings no biting penalty. Simply stated, making the promise is optimal but delivering the promise is not.

Since the pressure group has no significant pre-commitment to the promised behaviour, such as a large down payment in cash, and usually makes use of its discretionary powers to create pressure, the incentive to renege is operative, making their promise non-credible. It will therefore be unreasonable on the part of the regulator to expect that the promised behaviour will be carried out.

If an organisation unable to meet its obligations to its creditors does not face potentially higher costs for additional credit and/or enhanced social sanctions, it will not lose sleep over reputation risk. We have had our share of naming and shaming and Wikileaks moments. What difference did they make? Hence the need for changing the bailout model from rescheduling/restructuring to transparent budgetary support conditional on credible corporate management reforms. This of course is an interim solution until a comprehensive resolution to the NPL problem is found. 

The author is an economist.