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Simple discussion on some theories of banking and economics

M A  Khaleque

M A Khaleque

Sat, 30 Mar 24

In words, it is said, 'Not knowing something is not wrong, unwillingness to learn is wrong. And the biggest crime or injustice is pretending to know without knowing. Many among us are reluctant to show interest in learning about unfamiliar subjects. They behave as if they already know everything. Many try to display expertise in a subject they don't actually know well themselves. It's impossible for a person to know everything. However, continuous efforts to learn are necessary so that one doesn't get trapped or humiliated in the net of ignorance. Mutual exchange of ideas can be considered the best way to acquire knowledge on a subject. Those of us who work with or discuss banking and economics often need to familiarize ourselves with various new terms or concepts. Without having basic or fundamental knowledge about these, one tends to become embarrassed. Therefore, let's discuss some terms or concepts related to banking and economics that we come across almost daily. It's worth mentioning that the discussion here will be very general and not from the perspective of an expert. Therefore, misunderstandings or misconceptions are natural.

Firstly, let's mention the concept of consumer surplus or buyer's surplus in the context of economic theory. In economics, there's a remarkable theory called consumer surplus or buyer's surplus. Its essence lies in the mentality of a consumer when they go to the market to buy a specific product. If a consumer can purchase that product at a price lower than their expected value in the real market, they experience a kind of mental satisfaction. This is what is termed as consumer surplus. However, in today's times, a consumer typically cannot purchase a product at a price lower than the expected price. Rather, they often have to pay a price higher than the expected value to buy a product. This situation is not explicitly defined in economics. Could we then call this phenomenon consumer depression? Perhaps, or maybe not.

In the business field, there are two terms: gross profit and net profit. Gross profit refers to the difference between income and expenses of a particular entity within a specific period, calculated before taxes and other liabilities are paid. As an example, let's say a company earned one crore taka during the fiscal year 2022-2023. Among this, it incurred expenses worth fifty lakh taka. Therefore, the operational profit of that company would be fifty lakh taka. After deducting the salaries of the employed workers and various types of taxes paid by the company, it may be left with twenty-five lakh taka. This would be described as the net profit of the respective company.

In banking law, there is a term called "write-off" or "loan write-off." As soon as the word "forfeiture" is uttered, an idea is created in our mind that the bank may have waived the loan claim or waived the loan. However, this is not accurate at all. On January 3, 2010, Bangladesh Development Bank Limited (BDBL) was officially inaugurated. During the inauguration ceremony, the Chairman of the bank's Board of Directors disclosed that the outstanding loans for nearly 400 projects, which were waived by the bank, amounted to approximately 2400 crore taka. A journalist from an English national daily called me late at night to inquire about how banks keep track of loans near projects that have been written off. I could sense that they didn't have a clear understanding of loan write-offs. I informed them about the concept of loan write-offs, clarifying that it doesn't necessarily mean abandoning the claim of a loan in its entirety, which is a misconception many people still hold. Loan write-offs involve excluding specific loans from the ledger of bad debts based on certain conditions without including them as bad debts elsewhere. Banks never completely abandon their claims on written-off loans. Loans that have been written off are kept without attempting to recover the installment payments. If a loan account remains overdue for more than 5 years after being classified as non-performing, the relevant company's management can be taken to court, and after preserving 100% provision, the loan account can be written off. This rule was amended a few days ago. Now, if a loan account remains overdue for more than three years after being classified as non-performing, it can be written off. The provision of preserving 100% provision has been repealed for this purpose. The provision for filing a case against the promoters of projects with loans of less than 5 lakh taka has been revoked. Banks never abandon their claims on loans under any circumstances. However, the bank authorities believe that installment payments will not be collected from written-off loan accounts. Therefore, if any amount is recovered from written-off loan accounts, it is directly added to the bank's profit.

In the context of loan provisioning or loan savings, banks may focus on collecting funds. Banks do not conduct business with their own funds. They gather money from the public in the form of deposits and provide loans to entrepreneurs using that money. The spread of a bank refers to the difference between the interest rate it pays to depositors on their savings and the interest rate it charges to borrowers for loans. For example, if a bank is paying depositors an interest rate of 8% and charging borrowers or entrepreneurs a rate of 12% for loans, then the bank's spread would be 4% (12% - 8% = 4%). From this spread, the bank covers its expenses, including employee salaries, benefits, taxes, and other overhead costs. Whatever remains after covering expenses constitutes the bank's profit or earnings. In the banking sector, various types of loans are categorized into several classes based on the basis of their installment repayment. For each class of loans, a specific provision is required to be maintained for loan security provisions. For example, if regular installments are collected from a loan account, it is called a regular loan account. A provision must be maintained at a rate of one percent for this class of loan accounts. A loan account where periodic repayments are occasionally unsuccessful but regular repayments are eventually made is termed as sub-standard or doubtful loan account. For this type of loan account, a provision of 20 percent must be maintained. The bank authorities become cautious regarding the repayment of installments from such loan accounts. Therefore, this type of loan account is referred to as doubtful or sub-standard loan account. For this category of loan accounts, a provision of 50 percent must be maintained. If there is no possibility of repayment of installments from a loan account, it is classified as a bad loan or non-performing loan. A provision of 100 percent must be maintained for bad loan accounts. A specific timeframe is set for the classification of loan accounts.

In the banking sector, loan account restructuring or loan account rescheduling is a term commonly heard. Loan account rescheduling refers to redefining the repayment schedule of a loan account. For example, if a company's loan installment payment is due on December 31st, but the company is unable to make the installment payment on time, in such a case, the company can deposit a specified amount of money as a cash down payment to the bank and extend the loan repayment deadline. Previously, to reschedule a loan account, a down payment ranging from 10 percent to 30 percent had to be deposited with the bank. However, a few years ago, the opportunity for loan account rescheduling for a period of 10 years, including a grace period of one year, was allowed by depositing a down payment of 2 percent. The previous law was of international standard. However, through amendments, that law has been weakened. Loan account rescheduling is a simple way or method of showing a company as free from defaulted loans for a specified period without repaying the loan installments.

We often hear about "black money" and undisclosed money . Many people think that black money and undisclosed money are the same thing. In reality, they are not. Money is not characterized by its color. Instead, the term "black money" is used to describe money earned through illegal or unethical means and is kept outside the country's tax network. For example, if someone earns money through arms trading, theft, or any other illegal means and does not pay taxes on the earned money according to prevailing laws, then that money may be termed as black money. "Undisclosed money" refers to money that is earned legally but is not declared for tax purposes according to the prevailing laws of the country. Owners of black money commit two offenses simultaneously. On the other hand, owners of undisclosed money commit only one offense.

When the topic of black money and undisclosed money arises, the issue of money laundering often comes into play. Many people are confused about money laundering. Once I asked a renowned economist in the country to explain what money laundering is. He unequivocally stated that money laundering is synonymous with smuggling money. However, his statement is not entirely accurate. Smuggling money is just one technique of money laundering. Therefore, it is incorrect to equate money laundering with smuggling money. Money smuggling occurs when funds are moved between one country and another. And Money laundering involves the clandestine transfer of funds acquired through illegal means or undisclosed sources, both within a country and across borders. Its purpose is to legitimize illicitly obtained money and undisclosed money through various transformation and relocation processes, thereby integrating them into the mainstream economy of a country. Some believe that the term "money laundering" originated from the word "launder," akin to how dirty clothes are cleaned in laundry. Just as laundry cleans dirty clothes, money laundering seeks to legitimize illicit funds.

In economics, there is a theory called the 'Trickle-down Effect.' Proponents of this theory believe that if different economic benefits and tax exemptions are provided to the financial elite, they will establish various industries. The poor people will then work in these establishments and be able to sustain their livelihoods. This is only a manifestation of capitalist ideology.

There is a theory called Behavioral Economics. A few years ago, an economist named Richard Thaler conducted research on behavioral economics and received the Nobel Prize. The main proposition of this theory is that when the price of a product decreases in the market, consumers undergo a certain behavioral change. They become more enthusiastic or eager to purchase the product in larger quantities compared to before. We often observe this phenomenon in our daily lives. The essence of economics revolves around human beings. Nothing exists in economics without considering humans. Indeed, human behavior is highlighted through various theories of economics.

Author: Retired General Manager, Bangladesh Development Bank Limited, and writer on economic subjects.

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