Rising non-performing loans
The ability of the monetary policy to influence credit and the real economy is a central concern for Bangladesh. Relevant channels are, however, weak; and changes in policy rates have only a limited effect on other interest rates and on the economy. Since Bangladesh is a bank-dependent country, more liquid banks can enhance the impact of monetary policy on credit supply and the real economy. Similarly, financial development can strengthen the macroeconomic impact of monetary policy.
Banks in Bangladesh suffer from high levels of non-performing loans (NPLs) which reached 10.8 percent in March 2018. Further, NPLs weigh on the supply of credit and thus on investment and growth via a number of channels, such as locking-in bank capital into unviable projects and unproductive activities, reducing bank profitability, and distorting capital allocation. High NPL levels also impair the mechanism of monetary transmission to the real economy.
Moreover, high NPLs do not remain as problems for the banks alone. The government usually gets involved in a big way especially in the resolution process, through measures such as injection of capital especially into the failing public-sector banks, setting up of asset management companies (AMCs), etc. NPLs also have a significant impact on the fiscal sector through contingent fiscal liabilities; and the government, at times, ends up bailing out the financial institutions through recapitalisation.
Why do banks accumulate NPLs? Several factors contribute to the deterioration of the loan quality of banks. Some analysts point to macroeconomic factors such as financial mismanagement; others point to policy lending by the banks usually at the behest of the government—still others find links to weaknesses in bank regulations, poor bank management, corruption, and unscrupulous practices. The state-owned banks often act as if they are fiscal agencies, providing poor follow-ups once a loan is disbursed. Heavy bank losses usually result from poor quality of assets.
Some studies point to financial liberalisation, lax monetary policy and capital inflows as factors that contribute to increased liquidity in the economy. Increased liquidity, in turn, affects the lending behaviour of banks and encourages them to engage in reckless lending, often leading to asset bubbles, particularly in equity and real estate prices. As a consequence, the banks' crucial role of financial intermediation is hampered.
Effective prudential regulation and supervision of banks are essential for financial stability and efficient operation of the economy because the banking system plays a central role in the payments system and in mobilisation and distribution of savings. In Bangladesh, although prudential regulations may appear adequate, the implementation is often inconsistent, leading to a moral hazard behaviour by the banking and corporate sectors.
In addition, lack of efficient and functioning insolvency laws or bankruptcy and foreclosure laws to support asset recovery and to deal with timely credit repayment not only accelerates the NPL accumulation process but also sets a barrier in the efficient and swift disposition of NPLs. Besides the effects on bank intermediation, factors affecting NPL resolution vary considerably. There are important institutional factors or political will or inherent business cultures that are important determinants.
Several countries have used asset management companies (AMCs) to rapidly clean up the books of banks of bad assets. The usual procedure is that banks unload nonperforming assets to an AMC, clean up their books, and continue with its primary role of financial intermediation. The AMCs—either government- or privately-owned—then dispose the acquired assets through a variety of means such as public auctions, resale of assets to original borrowers, joint ventures, securitisation, or even running the acquired business themselves.
In terms of the institutional design, six criteria are considered important for an AMC's successful operation: 1) objectives (clear and non-conflicting); 2) management style (e.g. AMC is willing to consider new operational strategies such as joint ventures); 3) human resources (e.g. sufficient expertise and skills in associated areas); 4) funding availability (e.g. availability of government guarantees or adequate funds relative to the level of bad assets to be disposed of); 5) relative portfolio size; and 6) political will (e.g. whether or not the AMC has extrajudicial power to accommodate rapid debt resolution). These are necessary for ensuring efficiency, flexibility and transparency of the AMC.
In general, empirical evidence from several countries suggest that AMCs help expedite the restructuring or resolution of a huge stock of NPLs. They can also be instrumental in stopping the deterioration of banking sector profitability. However, the design of an AMC has a significant effect on its performance. There appears to be a trend towards establishing private—instead of public or government-funded—AMC that is strong in management and human resources. The private sector route may be followed through special-purpose vehicles (SPVs), which may have less concern about political interference and funding. SPVs are private sector-owned AMCs that normally buy bad assets and dispose of them for profit.
The varied performance of AMCs in different countries shows that the establishment of AMC is not, by itself, a panacea. There are preconditions and supportive institutional setups that facilitate its operation and render it more effective. AMC needs to have independence from political interference, sufficient financial resources, adequate pool of experts, and well-focused objectives. Successful AMCs may even be endowed with special legal powers to overcome the complex judicial procedures for asset recovery.
Since high GDP growth can reduce the cost, one policy to resolve NPLs is proper macroeconomic management that facilitates stability and growth. The government also needs to ensure an institutional and legal framework conducive to a speedy restructuring and resolution of the assets transferred to the AMCs from banks. The judicial and legal framework for insolvency should be efficient and least time-consuming.
Thus, successful AMCs can help banks improve their balance-sheet picture, thereby allowing them to free up capital for lending. On the other hand, for successful restructuring of NPLs into high-value uses, a supportive institutional and legal framework is crucial. The government may decide to set up special bankruptcy courts to attend to AMC-transferred assets cases only, along with strict time-bound proceedings including the appeal process. These measures will help increase the price offered by AMCs to the banks as the residual value of restructured NPL assets will increase, thereby encouraging banks to release the better-priced bad loans.
The global experience points to one lesson: NPLs do not disappear with time. NPL problems only grow worse with time unless there is a political will to resolve them.
Mustafa K Mujeri is Executive Director, Institute for Inclusive Finance and Development (InM).
Email: mujeri48@gmail.com
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