Why loans turn bad
As of March 2021, the total outstanding loans in the banking sector in Bangladesh stood at Tk 111,1940 crore. Out of this, an amount of Tk 95,090 crore was classified, equivalent to 8.48 per cent of the total loans. Though the amount is not too big with regard to our experience in the early eighties or even nineties, we have reasons to be concerned, particularly when the size of the classified loans is increasing or temporarily even reduced due to some episodic or artificial measures.
This is more alarming when most banks in Bangladesh can't claim to have a robust risk management culture. The recent stress test, carried out by the central bank, also revealed some disquieting developments.
Due to the concentration of loans within a few large borrowers, many banks run the risk of going "belly up" during any possible economic meltdown or challenging period.
We went through an era of 30 to 40 per cent classified loans. Along with the banking sector reforms driven by the development partners with the active support from the Bangladesh Bank, credit goes to the risk managers at private and foreign commercial banks, who contributed significantly towards the improvement of their asset portfolio despite large growth.
My background as a risk officer for almost 15 years with global banks taught me one fact: loans usually go bad due to improper or weak need assessment, wrong structuring of the facilities, security or collateral shortfall, and weak internal cash generation in the business leading to recurring past dues.
Other factors include lending on the basis of names of the borrowers without looking into their business fundamentals or future potentials or even succession, ignorance about competition or emerging competition, and economic downturn or investment in the business segments other than the core ones having relevance to the future or the economy.
Added to these are, of course, weak loan appraisal, failure to understand foreign exchange risk where cross-border exposures are taken, corruption or failure of the lending officers, and weak or no approval condition or covenant compliance or monitoring.
A client may always be desperate to get the loan approved or disbursed. It is the job of the lending officer to make sure that he or she has recognised all risks associated with that portfolio or specific business and taken enough measures to mitigate those risks.
We have seen how a large textiles client went through recurring past dues due to the wrong repayment structure of the loan. While the trade cycle dictated that end-to-end transactions would take 105 days, the loans disbursed for 90 days period created all these troubles for both parties.
In the same way, we have seen how a large local bank had to provide a large sum of money due to the sudden demise of a large tannery client, having no identified succession.
The Chattogram branch of a foreign bank suffered a lot due to the 210-day bullet repayment facility granted to a ship-breaking client, whose sales proceed started to come in from 30 days but were diverted to other businesses, not deposited with the bank account.
A large borrower of a state-owned bank became a defaulter right after disbursement of the term loan as his project cost went through the roof for his failure to cover himself against the exchange rate fluctuation in German Mark in those days.
A large distributor of a global consumer goods company became a defaulter because all his money borrowed from the bank was invested in purchasing land, not in the consumer durables distribution business.
The lending officers often become captive to large clients due to their perceived "muscle power" or "business power" or at times even "emotional blackmailing". In most cases, these large clients dictate the terms.
If a client needs Tk 100 and we give them Tk 200, they are bound to divert the excess money out of business or become undisciplined with regard to timely repayment. No matter who the client is or what their business is, a loan officer must do an in-depth need assessment to find out how much the client needs to run their business and in what form.
One must look at the business model, the projected turnover, and the tenure of an end-to-end transaction before deriving a figure for facility structuring.
Even if one derives a figure, one must know how much of that would be bank-financed and how much by the owners. The security or collateral provided must be valued by a proper agency or put up on a mark to the market valuation process. In the same way, outstanding can also be reviewed against security or collateral held.
I have also seen loans going bad due to non-compliance with regulatory imperatives, like waste treatment plants, river pollution or even neighbourhood pollution. The social activist groups forced the agencies to close down the plants.
Faulty title of land and grabbing of school or prayer places also created problems in the erection of plants, compelling the companies to relocate and thereby increasing the project costs.
The business being not relevant to the core strength of the key entrepreneurs also didn't help many repayments. Most importantly, one has to be with the winners in each of the business segments, not with the losers.
If one would want to penetrate further into the client segment with some security/collateral or even inadequate cash generation with some compromises, pricing must be reflective of the inherent risk or the government must subsidise to encourage money flowing to those priority sectors.
Many banks or financial institutions in Bangladesh don't have a risk policy of their own or any structured approach to loan appraisal, disbursement and repayment. I have seen many financial institutions having a large pool of people in their loan or credit departments, yet totally dependent on the board for each loan approval.
Appropriate valuation culture of the security or collateral is absent in many of these organisations. Facilities are granted without recognising the business or trade cycle. The resultant effect is loan losses, forced provision, capital erosion, profitability drops, and fall in share prices.
A robust risk management culture with a dynamic risk management policy can help financial institutions avoid such losses. Along with that, more important is the deployment of right people for risk management.
If we disburse a loan of Tk 100 crore, we can hardly make Tk 3 or Tk 4 crore as net earnings. However, if we get into troubled loan of the same amount, we lose the entire Tk 100 crore along with loss of reputation and employee de-motivation, if not some heavy collateral damage too.
The author is an analyst.