The economic consequence of non-performing loans

Non-performing loans (NPL) have become a worrisome issue for Bangladesh. Due to the ever-increasing volume of non-performing loans, our banking sector and the economy in general have taken a negative turn. According to newspaper reports, NPLs have already crossed taka one lakh crore, a first in the history of our banking sector. NPL accounts for 10.41 percent of the total loans given. The figure was 9.31 percent in December last year. The rising trend of the NPL is bound to have a long-lasting negative impact on the country's financial sector. 

If loanable funds are blocked as NPL, banks will not have enough reserve for issuing future loans, which will affect the economy in multiple ways. For example, it will hinder employment generation. The scarcity of loanable funds for private sector will widen the rich-poor gap in society. The rising trend of NPL will also have a negative impact on the banks' profitability.

Provisioning against defaulted loans will also jeopardise the financial health of many institutions. Banks have to keep provisions against their non-performing loans as per the central bank's guidelines. The provision amounts are kept aside from the banks' profits. When provisioning amounts become higher than the profits of a bank, it has to provision amounts from its capital, which can result in capital shortfalls. Capital shortfalls in turn hamper trade activities with overseas banks.

It must be mentioned here that our state-owned banks and some private banks are also facing capital shortfalls due to loan defaults of a good number of big borrowers. In case of government banks, capital shortfall amounts had been replenished through public money; the government has spent thousands of crores of taka in the last decade to recapitalise moribund government banks.

The huge amount of NPL will accelerate the operating costs of the banks, which will increase the lending rates. This scenario will make it difficult for the good borrowers to get loans at reasonable rates. This might also result in borrowers not getting loans due to liquidity crunch. A soaring NPL may also exacerbate the liquidity crisis and banks' ability to pay the money to its depositors, which can potentially trigger the banks' reputational risk.

We have seen what consequences defaulted loans can lead to. There are many reasons behind the rise of non-performing loans in the banking sector. First of all, political influence is one of the big reasons why defaulted loans are soaring. Political parties in power always use their influence to secure loans for the desired candidates. Over the years, many high officials have been appointed in the state-owned banks with political influence, who have put the banking sector in jeopardy by unethically giving loans to devious customers. A number of new banks were established on political grounds. Consequently, some third-generation banks were involved in massive loan scams which has resulted in significant damage to the financial health of the banking sector.

Issuing of loan to bad borrowers is another reason behind the rise of NPLs.Bank officials lack knowledge about the potential customers, thus they wrongly select bad borrowers who later turn into wilful defaulters.

Lack of good governance in the banking sector is another important factor behind the rise of NPLs. Big loan defaulters are getting various facilities to reschedule their payment of borrowed amounts. Due to lack of good governance, this problem is increasing. Enforcement of good governance—accountability, transparency and rule of law—can bring the banking sector to the right track.

Under our existing laws, it takes eight to ten years or more to resolve any bank-related case, especially those involving huge amounts. Moreover, there are many loopholes in the existing laws which work in favour of the loan defaulters.

The banking sector needs more stringent loan-issuing policies and their enforcement, in order to tackle the problem of NPLs. Bangladesh Bank should be given more authority and power so that it can take prompt initiatives to address the NPL crisis. Bangladesh should enrich its database and provide detailed information on loan defaulters, which can then act as a vetting factor in the selection process of clients.

Loan defaulters should be brought to book and their businesses should be curtailed. Bangladesh Bank officials should be able to exercise their power without fear and favour against loan defaulters. Political interference must be stopped in awarding loans and advances to borrowers. Governance in the banking sector should be made transparent and the governance bodies should be empowered to make objective decisions while issuing loans. It is only a combination of a strong political will and concerted efforts of all parties involved that can address the problem of non-performing loans; otherwise, the banking sector and our economy will have to pay the price for it.

Mohammad Zonaed Emran is a banker.