Emphasizing loan recovery over redefining defaulted loans

Bangladesh Bank on November 27 issued a notification reducing the timeframe for determining defaulted loans. The revised policy will come into effect on April 1. Under the previous government, a special provision was made for loan defaulters, allowing a grace period of six months for the recovery of overdue installments on term loans. This meant that even if an installment on a term loan was not paid on time, the loan would not be categorized as defaulted for another six months. With the amendment to the existing law, if an installment is not paid on time, the loan will be classified as defaulted from the very next day. Many believe that Bangladesh Bank has introduced a new definition for defaulted loans, but that is not the case.

Before the legal changes under the previous government, the law already stipulated that if an installment was not paid on the due date, the loan would be marked as defaulted from the following day. Therefore, this is not a new law, but a return to the old law. According to the new policy, if any loan installment remains unpaid for 90 days (three months), the loan will be classified as defaulted from the very next day. Economists predict that this change will initially cause the amount of defaulted loans in the banking sector to double. At the same time, provisions for the increased defaulted loans will also rise. As a result, banks may face reduced lending capacity. However, many believe that this measure will provide a more accurate picture of the actual state of defaulted loans in the banking sector.

According to international standards, if an installment on a loan is not paid on time, the loan account is classified as defaulted from the very next day. Once a loan is labeled as defaulted, the borrower loses the right to obtain new loans from any bank or financial institution. Additionally, other measures applicable to defaulters come into effect. During the previous government’s tenure, a powerful group of businesspeople and entrepreneurs exerted undue influence on the financial sector, taking advantage of the situation. This group was able to secure a grace period of up to six months for overdue loans, even beyond the stipulated time, which worsened the condition of the banking sector. Despite being defaulters, they were able to obtain loans from other banks and financial institutions for up to a year. With the new notification in effect, this opportunity will be significantly limited.

The new policy issued through the notification divides loan accounts into five categories based on the status of the loans. Accounts that make regular payments on time will be considered "Standard Loans." A provision of 1 per cent must be set aside for these loans. If a loan account remains overdue for 2 to 3 months, it will be classified as a "Special Mention Account (SMA)." For such loans, a 5 per cent provision will be required. Sub-standard or low-quality loans are those accounts that occasionally default but are later regularized by the borrower. A 20 per cent provision will need to be maintained for these loans.

If an installment on a loan remains unpaid for 6 to 12 months after the scheduled due date, the loan will be classified as a "Doubtful Loan." A provision of 50 per cent must be set aside for such loans. If an installment remains unpaid for more than 12 months, the loan will be categorized as a "Bad Loan," for which 100 per cent provision will be required. The question is, what impact will the stricter loan classification policy have on the banking sector? The attempt to artificially reduce the volume of loans in the banking sector by not collecting installments during the previous government’s tenure will be somewhat diminished. However, this one initiative alone will not be enough to provide an accurate picture of the actual volume of defaulted loans in the entire banking sector.

To truly understand the real extent of defaulted loans in the banking sector, further policy amendments are needed. Under the previous government, particularly during the tenure of Finance Minister AHM Mustafa Kamal, various tactics were used to reduce the reported amount of defaulted loans without collecting the installments. According to the latest data from Bangladesh Bank, the amount of defaulted loans stood at 2.84 trillion BDT as of September. However, this figure does not reflect the true extent of defaulted loans. A senior official at Bangladesh Bank has stated that currently, 12 per cent of the total loans disbursed by banks are being shown as defaulted. The amount of defaulted loans is expected to rise continuously. Within the next few months, defaulted loans could rise to 35-40 per cent of the total loans disbursed.

Various legal reforms have been implemented to reduce the amount of defaulted loans without collecting installments. These legal reforms have weakened the loan recovery process, although Bangladesh Bank has managed to show a reduced figure for visible defaulted loans. According to the observations of the White paper committee on economy formed by the interim government, the statistics on distressed loans in the banking sector are alarming. The White Paper Committee noted that by the end of June, the total distressed loans in the banking sector amounted to 6.75 trillion BDT, with the reported amount of defaulted loans being 2.11 trillion BDT. The tendency to hide defaulted loans by not collecting installments was compared by a renowned economist of the country to hiding dirt under a carpet. Just like dirt hidden under a carpet will eventually emit a smell, similarly, hiding defaulted loans through legal loopholes will lead to a disaster for the banking sector. And that is exactly what is happening now.

An abnormal process of hiding defaulted loans or showing them as regular loans through legal procedures became apparent in 2015. During that year, between January and March, political unrest involving arson and vandalism began. Using the excuse of damages from this unrest, defaulted loans of 500 crore BDT or more were restructured. Although it was called restructuring, it was essentially a rescheduling of the loan accounts. With a down payment of just 1 to 2 percent in cash, the loan accounts were restructured for a period of 12 years. Eleven industrial groups took advantage of this opportunity to regularize 15,000 crore BDT worth of defaulted loans.

In 2019, borrowers were given the opportunity to reschedule their loan accounts for a total of 10 years with a one-year grace period, by making a down payment of just 2 per cent. As a result, loan rescheduling was carried out extensively. Previously, a loan account could only be rescheduled up to three times, with 10 per cent down payment for the first rescheduling, 20 per cent for the second, and 30 per cent for the third. When a loan account was rescheduled, it could not be classified as defaulted for a specified period. With just a 2 per cent down payment, 38,000 individuals and institutions regularized their defaulted loan accounts. Currently, the amount owed by banks for rescheduled loans stands at 2.72 trillion BDT.

Previously, when a loan account was classified as a bad loan, it could be written off after five years by filing a case in the appropriate court and making a 100 per cent provision for it. However, this law was changed, allowing loan accounts to be written off after being classified as bad for three years initially, and later for two years. If the outstanding amount of the loan account was less than 500,000 BDT, there was no requirement to file a case. Additionally, the provision for maintaining a 100 per cent provision was also withdrawn. According to June’s data, the total amount owed for written-off loans was 75.39 billion BDT, with 39.21 billion BDT classified as special loans. A further 76.18 billion BDT was under a court stay order. In total, the distressed loans amounted to 6.75 trillion BDT. This means that 4.64 trillion BDT of loans were defaulted, but they were not shown as defaulted loans.

In privately owned banks, a regulation was introduced allowing up to four directors to be appointed from the same family, with the provision that they could serve three consecutive terms of three years each, totaling nine years. Later, when Bangladesh took a loan of 470 million USD from the International Monetary Fund (IMF), the IMF imposed a condition to reduce the number of directors from the same family to three. As per IMF conditions, a law was enacted to identify willful loan defaulters, but its implementation is yet to be seen.

To prevent the rise of defaulted loans in the banking sector in the future, it is now essential to take appropriate measures. Some effective steps should be taken, such as identifying willful defaulters and imposing a ban on their participation in state functions and international travel. There should be proper valuation of the assets mortgaged to the bank at the time of loan application. If a bank official is found negligent in overvaluing mortgaged assets, they must be held accountable under the law. The personal movable and immovable property of the borrower and their family members can be seized and auctioned to recover the loan. Steps should also be taken to prevent the misuse of loan rescheduling benefits. A borrower should not be allowed to reschedule their loan account more than once. Additionally, those participating in national or local elections should be prohibited from rescheduling their loans at least one year prior to their participation.

The most important point is that a loan account does not become a default solely due to one party's actions. If the relevant bank officer, while assessing the loan application, does not succumb to pressure and performs their duties with utmost honesty and integrity, the likelihood of the loan becoming a default in the future significantly decreases. Immediate action must be taken for legal reforms in the banking sector. This is because expecting strict legal measures from a political government once they take office is nothing short of naive.

MA Khaleque: Retired General Manager, Bangladesh Development Bank PLC and Economist.