Minimising non-performing bank loans By Muhammad Bashir Chaudhry

THE banking system has been plagued with high non-performing loans, doubling to Rs432 billion over two years, ending December 2009.

As the percentage of total loans, these gross non-performing loans (NPLs) were 12.2 per cent as against 7.6 per cent at the end of December 2007.

The main factor for rising NPLs could be that borrowers are considered solely responsible for it. It is forgotten that certain actions or inactions by creditors as well as the government also aggravate the problem. In our system, no differentiation is made between the willful defaulters and the failure of unlucky entrepreneurs despite their best and honest efforts. The solution to this malaise could be found once we appreciate various contributing factors as well as the role of different stakeholders.

For example, the textile ministry recently introduced quota on yarn exports. The monthly limit was initially set at 50,000 tons which was later reduced to 35,000 tons despite protests by yarn exporters. The introduction of quota aimed at protecting the value-added sector. Such a unilateral is step is to the disadvantage of textile spinners and exporters, and the possibility that it will increase the textile sector’s non-performing debts cannot be ruled out.

Our economy is suffering, not entirely due to global crises, but because of reasons that have their local origin. Abnormal increase in rates of electricity, gas, water etc., coupled with frequent and long load-shedding, inadequate physical infrastructure and poor law and order, are a drag on business and are contributing towards loan defaults. The country is very low on the list of Global Competitiveness Index and the cost of doing business is very high. The loss to the economy is serious and so is the loss of potential returns to investors.

Some say that provision for NPLs is taken by many lenders more or less as a normal cost for doing business. Despite high provisioning for NPLs, they are able to make huge profits. These creditors are able to secure intermediation margin ranging between 7- 8 per cent on most loans other than those refinanced by the SBP for which intermediation margin may range between two and 2.5 per cent.

High intermediation margin at 7-8 per cent raises the overall cost of loans to borrowers and deprives small depositors of real positive rate of return. As a result, many industries become uncompetitive globally.

Also, the depositors are discouraged to place a major part of their savings with commercial banks. Such practices introduce distortion in the economy. The system of loan pricing and incentives for mobilisation of savings deserve careful remedial measures by the authorities.

The banks should review their lending policies, strengthen risk management systems and bolster their recovery regimes. The banks need to consider the following measures that have been found useful:

The NPLs fall into a number of categories and occur due to umpteen number of reasons. Depending upon careful study, each NPL may be dealt with on its merit. Some projects might require change of ownership and management. The senior management and the board of directors of the banks can minimise NPLs by proper monitoring of existing loans and careful appraisal of fresh requests for loans.

The two pre-requisites for achieving the objective are: assigning the credit function to competent, motivated, honest and extensively trained bank personnel and diligently following credit management policies throughout the credit cycle-credit origination, approval, security and loan documentation, procurement, disbursement and recovery. One weak link in the whole chain has the potential to jeopardise the entire process and turn the loans sour.

Wrong selection of borrowers is one of the main reasons for NPLs. The sponsors use loan proceeds, implement the project and repay the loan with profit as per agreed schedule. It is often alleged that the sponsors derived large personal benefits due to which the companies defaulted in debt servicing. There may be quite a few such cases. However, it is felt that the sponsors in most cases are also ruined if their projects fail, as most of them lose their stake, raised mostly through loans from relatives and friends. The defaulters deserve to be treated fairly.

Most NPLs can be traced to delays in implementation of projects. Delays generally result into cost over-runs, which, per force, are financed by the existing creditors and / or the main sponsors. If more bank loan is not available, a normal project may run into problems. The creditors, however, have to be more careful if delays are due to mismanagement or dubious practices.

In carrying out credit operations and tackling of NPLs, the banks might adopt the practice of periodically scrutinising the integrity of the entire loaning process including appropriateness of the organisation for credit function, delegation of sanctioning powers, internal controls including check and balances for monitoring the performance of the bank teams and credit guidelines covering different phases of the credit cycle.

The projects sometimes face problems that are beyond the control of the project sponsors. The banks might adopt a clear policy to take up the matter with the government if policy changes have the potential to turn their regular borrowers into defaulters. All efforts may be made for salvaging the investment in a fair manner.

SMEDA and the SBP can help in removing the apprehensions of individuals---- wanting petty loans for small business or for personal reasons--- that they are not always treated fairly particularly at recovery stage. The borrowers have to be careful to ensure that banks do not exploit their position in prescribing one-sided terms and conditions of loans and advances.

In order to help manage the credit risk, the government may initiate stringent reforms to stabilise the economy and place it on a sustainable path of development. Many lessons for future can be learnt if existing NPLs, particularly the big ones involving many banks, are reviewed by special joint teams of bank officers and regulators. Based on a detailed study of the causes of these NPLs, case studies can be developed for future training of officials from banks, government and regulatory authorities.

Source: http://www.dawn.com/wps/wcm/connect/dawn-content-library/dawn/in-paper-magazine/economic-and-business/minimising-nonperforming-bank-loans-240