“The Scenario of Non-Performing loans in Bangladesh: Causes, Pitfalls and Remedies”

Faculty of Business Studies

Department of Banking and Insurance
(EMBA Program)
“The Scenario of Non-Performing loans in Bangladesh: Causes,
Pitfalls and Remedies”
Submitted to:
Nazmul Hasan Palash
Assistant Professor, Department of Banking and Insurance,
University of Dhaka
Course Instructor-Credit Management in Banks
Submitted by-
Name ID Batch Signature

Arup Kumar Saha 51429038 29th

Date of Submission-Saturday, April 30, 2016

Semester-Spring 2015

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 “The Scenario of Non-Performing loans in Bangladesh: Causes, Pitfalls and Remedies”

LETTER OF TRANSMITTAL

30th April, 2016

Assistant Professor, Nazmul Hasan Palash

Faculty of Business Studies

Department of Banking and Insurance

University of Dhaka

Subject: Submission of Term Paper.

Dear Sir,

I am pleased to submit the Dissertation report on “The Scenario of Non-Performing loans in

Bangladesh: Causes, Pitfalls and Remedies” for partial fulfillment of Credit Management in
Banks course. It has been a great experience for me to prepare a report where I can practically
apply all academic theory that I have learned throughout the course. I tried my level best to
put meticulous efforts for the preparation of this report. Any shortcomings or flaw may arise
as I am novice in this aspect.
I have tried to make each and every element relevant to my topic and discussed under the
context of whatever I have learned from the course. It would be pleasure for me, if this report
can serve its purposes.

Thanks and Regards

Yours Faithfully

Name: Arup Kumar Saha

ID: 51429038
Department of Banking and Insurance, EMBA Program
University of Dhaka

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 “The Scenario of Non-Performing loans in Bangladesh: Causes, Pitfalls and Remedies”

Executive Summary

Nonperforming loans is common phenomena for banking industry in Bangladesh. A Non-

performing loan is a loan that is in default or close to being in default. Many loans become
non-performing after being in default for 90 days, but this can depend on the contract terms.
NPLs started at the early stage of liberation. During 1980s and 1990s, Privatization and
liberalization of banking sector could not control NPLs. Rate of NPLs was 41.1% in 1999.
Now it is 11.90%.The amount of NPLs increased to taka 73.3 billion in 2012 from taka 47.3
billion in 2003.There are many reasons behind the NPLs in Bangladesh. First reason is
entrepreneurs related. Borrower may be have lack of experience, lack of business and lack of
institutional training background or lack of supporting facility. Sometime borrowers do it
intentionally. Entrepreneurs age also an important factor. Second reason is business related.
Sometime banks give loan to businesses which are not attractive. Strong competition is
another business related cause. Borrower becomes defaulter if there is poor management
capability, poor financial performance, and poor cash flow. Business could be defaulter
because of low market share. Low market share mean low revenue so that business cannot
pay the interest payment. Third reason is leading related. It is mainly Bank’s fault. Loan
could be default if Bank delayed assessment of loan proposal, delayed disbursement of fund,
lack of proper monitoring, lack of taking proper action. Last reason is macroeconomic
factors. Low GDP growth, increasing crimes, hartals and frequent policy change effect loan.
For those reasons loans become default loan. Effects of NPL are such as Stopping Money
Cycling, Earning Reduction, Capital Erosion, Increase in Loan Pricing, Frustration etc. As a
result, the values of security are increased and the risks of financial recession also see a rise.

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 “The Scenario of Non-Performing loans in Bangladesh: Causes, Pitfalls and Remedies”

Table of Contents

LETTER OF TRANSMITTAL .............................................................................................................. 2

Executive Summary ................................................................................................................................ 3
Part 1: Introductive part .......................................................................................................................... 5
1.1 Background of the study ............................................................................................................... 5
1.2 Objectives of the study.................................................................................................................. 6
1.3 Methodology ................................................................................................................................. 6
1.4 Scope and limitations .................................................................................................................... 6
1.5 Structure of the study .................................................................................................................... 6
Part 2: Descriptive part ........................................................................................................................... 7
2.1 Definition of Non-performing loans ............................................................................................. 7
2.2 The Present status of Loan Defaults Culture in Bangladesh: ........................................................ 9
2.3 Present Status of Non-performing Loans: ................................................................................... 11
2.4 Causes of Loan Default Problem ................................................................................................ 12
2.5 Pitfalls of Non-performing loans: ............................................................................................... 16
2.6 Indicators of Default Loan: ......................................................................................................... 18
2.7 Strategies for remedies of non-performing loans ........................................................................ 19
Part 3: Conclusive part .......................................................................................................................... 23
3.1 Findings: ..................................................................................................................................... 23
3.2 Recommendation ........................................................................................................................ 24
3.3 Conclusion .................................................................................................................................. 25
3.4 Reference .................................................................................................................................... 26

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 “The Scenario of Non-Performing loans in Bangladesh: Causes, Pitfalls and Remedies”

Part 1: Introductive part

1.1 Background of the study

Most of the business is done by banks with the funds which are collected from the public by
way of deposits. A non-performing asset in the banking sector may be termed as an asset
not contributing to the income of the bank. In other words, it is a zero yield asset when
applied particularly to loan and advances. The actual concept of NPA is that it is an asset
which ceases to yield income for the bank and that any income accrued from such asset
shall not be treated as income until it is actually realized. Classification of an asset as NPA
should be a based on record of recovery. Therefore, an asset is to be classified as NPA
when there is a threat of loss for the recoverability is in doubt. In spite of wide ranging
reform measures initiated in the banking sector, the problem of non-performing assets
assumed a central place in issues relating to banking sector.

Lending function of a bank needs to add value to the bank. The lending function comprises
origination, funding, monitoring and servicing of loan. Loans are deemed as assets of a
bank. To maintain asset to a standard quality various prudential regulation from various
angle, issued by central bank such as, loan classification criteria, provisioning requirement,
income recognition, write-off policy, risk diversification, directed lending, debt
restructuring etc.

In the absence of strong capital market, Bangladesh depends heavily on the banking sector
for a smooth financial intermediation. However, for many years Bangladeshi banking sector
has been burdened with the crisis of accumulation of huge non-performing loans. All types
of domestic banks i.e. NCBs, PCBs and DFIs are facing the daunting amount of non-
performing loan. Since 1980s, the central banks of the developing countries, following the
practices of the developed countries, have adopted the "prudential norms for asset
classification", with a view to ensuring "transparency" and "quality" of the loan portfolios
of the banks. It is a part of Financial Sector Reform Program (FSRP).

It is obvious that NPLs reduce banks’ profitability, as banks cannot appropriate interest
income from their classified loans. NPLs reduce loan able funds by stopping recycling.
Banks need to set aside a portion of their income as loan loss reserve to make up bad debt. A
bank with a high percentage of NPLs suffers from erosion of the capital if there is no
provision (assume). All those adverse impact of NPLs on banks’ financial health such as
low profitability and low capital base are clearly reflected in Bangladesh banking sector.

The ratio of NPL to total loans of all the banks had shown an overall declining trend
from its peak 34.9% percent to 10 percent in December 2012.The ratio further increased to
11.9 percent at the end of June 2013.

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 “The Scenario of Non-Performing loans in Bangladesh: Causes, Pitfalls and Remedies”

1.2 Objectives of the study

The objectives of this report are -

 To assess the present situation of non-performing loans in our banking sector.

 To show the trend of the “loan default problem’’ in Bangladesh.
 To examine present situation of non-performing loans in Bangladesh.
 To identify the causes of non-performing loans.
 To identify the pitfalls or risks associated with NPLs.
 To raise some issues and observations which need to be looked upon quickly for remedies
the current NPLs problems.

1.3 Methodology

The research methodology of the study has been enumerated below:

a. Sources of Data & Data Collection:
Data has been collected from the various secondary sources like research works of individuals,
different publications, journal of different institutions, reading materials, books, library sources,
Bangladesh Bank, CRG manual etc.
b. Time Preference:
The time preference of the study relates to the period covering the years 1990 to 2011. These 22
years has been taken for different analysis purposes.
c. Data Processing and Analysis:
Data processing has been done manually after checking and editing. Tabular techniques are used to
present data in this paper.

1.4 Scope and limitations

Non-performing Loan is very much important for the banking sector. Here the study would
be concentrate on laws and regulations and existing legal structure as well as status of NPL of
different commercial banks. Problems are always there for any research study. Effort was
there to overcome the limitations and to bring a reliable and fruitful result. The limitations of
the study are:
• This study did not cover primary and unpublished data.
• The major problem faced while conducting the research was unavailability of relevant
data.

1.5 Structure of the study

This research report has been divided into three parts. In the first chapter, introduction of the
report has been given. Here the background, Objectives of the study, methodology and scope
has been elaborated. In the second chapter, descriptive part of the report has been analyzed.
The third chapter portrays the findings, recommendation and conclusion part.

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 “The Scenario of Non-Performing loans in Bangladesh: Causes, Pitfalls and Remedies”

Part 2: Descriptive part

2.1 Definition of Non-performing loans

The words 'Rin Khelapi' and 'Ku Rin' are quite popular in our financial society. When a
borrower does not pay interest along with principal amount as per terms and conditions, then
s/he is called 'Rin Khelapi' (loan defaulter) and the loan is classified as 'Ku Rin' (bad debt).
As per Section 5 (cc) of Bank Company Act 1991, 'defaulting debtor' means any person or
institution served with advance, loan granted in favour of him or an institution involving
interest or any portion thereof, or any interest which has been overdue for six months in
accordance with the definition of Bangladesh Bank. Provided that, if a defaulting borrower is
not a director of any public limited company or does not hold more than 25 per cent of the
shares of that company, the said public limited company shall not be considered as an
interest-related institution: Provided further that, the shares of a borrower not exceeding 20
per cent other than a public limited company, which is cited as institution, shall not be
considered as an interest-concerning institution under the clause. Bad loans may not perform
to serve interest or principal, other charges, VAT, tax etc. That is why, it is called non-
performing loan (NPL). There are many definitions and explanations about NPL. However,
NPL has a big impact on any financial scenario.
Non-performing loans are also called non-performing assets (NPA), which are loans,
classified by a bank or a financial institute, at the instruction of the regulatory authority, on
which repayments or interest payments are not being made on scheduled time. A loan is an
asset for a bank as the interest payments and the repayment of the principal create a stream of
cash inflows. Interest cash inflow is excess money over principal, which is called profit.
Banks usually treat assets as non-performing, if they are not serviced in scheduled time. If
payments are late for a short time, a loan is classified as past due. Once a payment becomes
late (usually 60 days), the loan is classified as non-performing.
NPL is a sum either of the borrowed money upon which the debtor has not made his/her
scheduled payments, which is in default or close to being in default. Once a loan is non-
performing, the odds that it will be repaid in full are considered to be substantially lower. If
the debtor starts making payments against a non-performing loan, it becomes a performing
loan.

IMF definition: International Monetary Fund (IMF) defines that a loan is non-performing
when payments of interest and principal are past due by 90 days or more, or at least 90 days
of interest payments have been capitalised, refinanced or delayed by agreement, or payments
are less than 90 days overdue, but there are other good reasons to doubt that payments will be
made in full.
Classified Loan:
A classified loan is the term used for any loan that a bank examiner has deemed to be in
danger of defaulting. The borrower does not necessarily need to miss payments order for a
bank to label the account in this manner. A borrower can have what the bank calls a classified
loan for different reasons. This is simply a precaution that financial institutions take to

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 “The Scenario of Non-Performing loans in Bangladesh: Causes, Pitfalls and Remedies”

prepare for a possible loss and to prevent any further risk.

The Bangladesh Bank defines an 8-tier loan classifying system such as Superior, Good,
Acceptable, Marginal, Special Mention, Sub-standard (SS), Doubtful (DF) and Bad/ Loss
(BL). This is actually the key risk grading system in order to measure the assets' quality. This
grading must be used to check asset-quality periodically. Downgrading of any facility should
be informed in Early Alert Reporting (EAR) for decision-making authorities.

The loans are usually classified by the lending bank, whenever the bank has reasons to
believe that the borrower would not be able to repay the loan regardless of whether the loan is
overdue or not. Loans extended by a bank are classified into the following three categories.
i. Substandard: Advances which appear substantial degree of risk to bank by reason of
unfavorable record or other unsatisfactory characteristics.
ii. Doubtful: Advances the ultimate realization of which is doubtful and in which a substantial
loss is probable.
iii. Bad/Loss: Advances which may not be recoverable at all and entire loss is probable

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 “The Scenario of Non-Performing loans in Bangladesh: Causes, Pitfalls and Remedies”

2.2 The Present status of Loan Defaults Culture in Bangladesh:

As loans comprise the most important asset as well as the primary source of earning for the
banking financial institutions and on the other hand also the major source of risk for the bank
management so a prudent bank management should always try to make an appropriate
balance
between its return and risk involved with the loan portfolio. But Banking sectors recent
involving activities, guidelines and their concentration in that is not satisfactory.

The prudential guidelines also call for making adequate “provisions” against classified loans
in order to protect the financial health of the banks are prepared but which is meaningless as
by making provision the number of willful defaulters increasing day by day. The economic
implications of the non-performing/default loans are not only stoppage of creating new loans
but also the erosion of banks profitability, liquidity and solvency, which might sometimes
leader towards collapse of the baking financial system. It has therefore become sine qua non
for policy makers to study the loan default scenario of the banking sector of routine basis for
estimating classified loan, making appropriate provisioning, adopting effective recovery
strategy and thus ensuring soundness and efficiency of the banking sector.
Before privatization and liberalization this banking activities were thus directed to disburse
credit, according to the government’s economic priority, and hence little attention was placed
to identify the problem loans and making provisions thereon, although there was significant
amount of hidden default loans. After 1982, the banking sector of Bangladesh underwent a
rapid denationalization and privatization process. The out of six nationalized commercial
bank Uttara Bank and Pubali Bank were denationalized in 1983 and 1984 respectively with a
view to increasing the efficiency of the banking sector. Henceforward, private bank were
allowed to conduct banking operations in order to increase, competition, reasons, the
efficiency and productivity of the banking sector. But due the various reasons, the efficiency
of the banking sector did not increase rather the credit discipline was further eroded.
The very frequent and fashionable style of loan defaulting story in banking sector of
Bangladesh is loan scam. Recently a series of scams has started threatening the banking
sector in a great way. Last year, Sonali Bank loan scam started the episode and is continuing
with Bismillah loan scam, Basic Bank loan scam and so on in a large scale. The story of all
episodes is almost same and follows a cycle.
According to Anti-Corruption Commission, 41 reputed commercial banks in Bangladesh
were involved actively in Sonali bank scam of Tk.3665 crore with Hallmark(The Financial
Express). Over 100 branches of seven state-run banks, 29 private banks and five foreign
banks patronized that loan scam according to them.
In 2009, Bangladesh Shilpa Bank and Bangladesh Shilpa Rin Sangsta were merged due to
huge amount of NPL in both of them. The operational activities of BSRS came to a halt,
when its classified loans reached up to 85 to 90 percent of its total portfolio. The situation
was almost same for BSB although it tried to expand its deposit collection on its own rather
than rescheduling the previous non performing loans. It had about Tk 250 crore classified
loans on the eve of being merged, according to media reports.

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 “The Scenario of Non-Performing loans in Bangladesh: Causes, Pitfalls and Remedies”

Defaulted Loan between September 31, 2014 to March 31, 2015

(in crore)
Bank Name Defaulted Loan as of Defaulted Loan as of Defaulted Loan as of
Sept 31, 2014 Dec 31, 2014 March 31, 2015
SONALI 11,570.21 9629.29 10,432.43
AGRANI 4387.17 2605.26 3343.48
RUPALI 5118.36 3317.84 332354
BASIC 1697.45 1053.0 1588.57
BDBL 1883.27 1282.36 2557.54
AB 716.04 520.38 616.32
BANK ASIA 596.18 440.48 463..61
BRAC 899.01 580.92 979.90
DHAKA 783.85 750.70 840.23
DBBL 755.23 375.24 563.14
EBL 474.33 402.04 477.06
EXIM 597.96 369.82 427.55
FIRST 1003.29 516.82 677.02
SECURITY
ICB ISLAMIC 218.46 248.38 248.63
IBBL 749.28 717.59 725.88
JUMUNA 2788.33 1364.29 2065.99
ONE 331.40 173.10 281.45
MUTUAL 605.28 448.96 558.08
TRUST
NATIONAL 698.90 465.98 534.74

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 “The Scenario of Non-Performing loans in Bangladesh: Causes, Pitfalls and Remedies”

2.3 Present Status of Non-performing Loans:

The most important indicator intended to identify the asset quality in the loan portfolio is
the ratio of gross non-performing loans (NPLs) to total loans. In 2012 Foreign Commercial
Banks(FCBs) have the lowest and State owned Development Financial Institutions (DFIs)
have the highest ratio of gross NPLs to total loans. State owned commercial banks (SCBs)
had a gross NPLs to total loans of 23.9 percent, whereas Private Commercial Banks
(PCBs), FCBs , and DFIs, had ratios of 4.6,3.5 and 26.8 percent respectively at the end of
December 2012.
NPL ratios By( % ) of Banks

Bank 2007 2008 2009 2010 2011 2012 2013 2014 End
types June
2013
SCBs 21.4 22.9 29.9 25.4 21.4 15.7 11.3 23.9 26.4
DFIs 34.9 33.7 28.6 25.5 25.9 24.2 24.6 26.8 26.2
PCBs 5.6 5.5 5.0 4.4 3.9 3.2 2.9 4.6 6.6
FCBs 1.3 0.8 1.4 1.9 2.3 3.0 3.0 3.5 4.7
Total 13.6 13.2 13.2 10.8 9.2 7.3 6.1 10.0 11.9

The gross NPLs ratios to total loans for the SCBs, PCBs, FCBs and DFIs were recorded as
26.4, 6.6, 4.7 and 26.2 percent respectively at the end of June 2015. The ratio of NPLs of
all the banks had shown an overall declining trend from its peak (34.9 percent) I 2000 up to
2011 before it increased to 10.0 percent in December 2014.

The amount of NPLs of the SCBs increased from taka 105.7 billion in 2003 to taka 215.1
billion in 2014. The PCBs recorded a total increase of taka 81.8 billion in their NPL accounts,
which stood at taka 130.3billion in 2014 as against taka 48.5 billion in2003. The amount of
NPLs of the DFIs increased to taka 73.3billion in 2014 from taka 47.3 billion in 2003.
Sonali Bank has the Highest default loan (10,432.43 cores) and HSBC has the lowest default
loan(128.06 cores) among the banks at the end of March 2015. In September 2015, Sonali
Bank had the highest default loan (12570.21 cores) and HSBC had the lowest default loan
(109.05 cores).

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 “The Scenario of Non-Performing loans in Bangladesh: Causes, Pitfalls and Remedies”

2.4 Causes of Loan Default Problem

Entrepreneurs Related:

 Young Age:
Young age is one of the reasons behind the failure of payment of regular loan. Because of
young age people suffer from lack of business experience. On the other hand they normally
don‟t have enough banking experience. As they are young and lack experience, it may be one
of the reasons of default loan.

 Lack of Business Experience:

Sometimes people without prior business experience want to do something. It may so happen
that after retirement from govt. or private service people want to establish a business which is
not very relevant to his past experience. Besides his own equity they look for bank finance.
Normally banks do not finance in the projects where the key personnel do not have enough
background in that particular business. When banks finance in the projects where the key
personnel lack relevant business experience, it becomes risky for the bank. Probability of
failure in these sorts of projects tends to be higher.

 Lack of Business and Lack of Institutional Training Background:

Business experience is somehow related to business background. Here business background
means family business background. Though family business has a role in entrepreneurial
orientation, there is no direct relationship between business background and business
performance or loan repayment. It is true that youths coming from business background are
familiar with business and banking but there are other ways to get oriented with the same, not
necessarily one has to come from business family.

 Unwillingness to Pay:
We all know this is one of the most common reasons behind default culture in Bangladesh. It
can happen in some situations like when security backing loan is weak, customer feels that
defaulting the loan will not harm him much. In that case he tends to default. In other cases
like when cash flow from the business is not impressive, people are unwilling to repay the
loans. Even sometimes without any reason customers default loan that is purely
psychological and absolute unwillingness to repay loan.

 Lack of Supporting Facilities:

Sometimes business need support from other sources. When cash flow is lean and the project
is in lull, it needs feeding. Without further feeding company may become sick and incur loss
in consecutive time periods. In our country most of the companies do not have the supporting
sources with which they can withstand the turmoil that comes in to their business from time
to time.

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 “The Scenario of Non-Performing loans in Bangladesh: Causes, Pitfalls and Remedies”

Business Related:

 Non Attractive Industry:

Sometimes no attractive industry acts as primary cause of loan default. Companies operating
in non attractive industries have higher probability of performing poor. Because of poor
financial performance, company‟s cash flow gets affected. Because of cash flow the
company becomes less liquid which contributes in defaulting bank loan. Not necessarily that
all the companies of non attractive industry perform poor.

 Strong Competition:
Strong competition does not directly contribute in defaulting loan. Strong competition takes
place when many companies enter into an industry where the industry cannot accommodate
so many companies. In strong competition only efficient players survive. So the inefficient
companies find it difficult to make profit and sale their product. Once they fail to make profit,
the company is likely to default its loan installment in the bank.

 Poor Management Capability:

Before sanctioning a loan banks look in to the matter that how the management of the
company is. If the bank feels that the management is capable enough to successfully run the
business and utilize bank finance, then bank agree to finance otherwise not. Even sometimes
banks sets conditions like some of the key personnel must not quit the organization before
repayment of the loan. Managerial capability plays a vital role in repaying bank loan. The
more professional the management is the less probability of defaulting loan.

 Poor Financial Performance:

Definitely Poor financial performance is the most important cause of loan default. Once a
company is not solvent, it is un-likely to repay its loan. Poor financial performance is the key
reason behind maximum loan default. Poor financial performance can be arisen from many
other reasons described above.

 Poor Cash flow:

In most cases poor cash flow is the aftermath of poor financial performance. Because of poor
cash flow companies mainly default loan. Because of irregular cash flow, business becomes
unstable and illiquid. In that case business does not have enough cash to service loans
payment and interest. Even if a company is profitable, the company may default because of
cash flow. In some cases, a business may sell most of its finished goods in credit. So it may
not have enough cash to support the loan and other debts. So it may cause default.

 Low market share

Low market share may be a reason of loan default but not a single respondent mentioned it as
one of the reasons of their loan default. Low market share means low sales, low sales mean
low profit and low profit results default. But operating in a niche market, having a very low

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 “The Scenario of Non-Performing loans in Bangladesh: Causes, Pitfalls and Remedies”

market share a firm can be profitable enough to repay its entire loan obligation as well as
retain sizable earning.

Lending Related:

 Delayed Assessment of Loan Proposal:

Banks sometimes make delay in assessing loan proposals of the business firms. When the
firm badly needs money, it does not get enough funds because of delayed assessment by the
bank. This infuses shortage of cash in their business operations. They hardly manage their
day to day business expenses let alone repayment of the loans.

 Delayed Disbursement of Fund:

Even after assessment of the proposal and taking positive decision, banks do not disburse
funds until security documentation formalities are completed. As a result business do not get
fund when actually it requires it. Some of the defaulters complained about subsequent
disbursements.

 Lack of Proper Monitoring:

Monitoring is one of the most important parts in credit. Through monitoring lenders come to
know that whether their fund is being used for the desired purpose or not. Sometimes
disbursed money is used for purposes other than the specific areas. In that case risk of loan
default gets higher. Banks sanction loan on the basis of feasibility of the project. Bank as a
lender expect that the loan will be serviced by the cash flow generated from that particular
business. But if credit is used in some other areas desired cash flow may not come from the
business and chance of loan default gets high. Therefore banks monitor activities of the
borrower whether the fund is being properly utilized or business is generating enough cash
flow or not. Banks use specialized formats for loan monitoring. Bank periodically review the
performance of the borrower and based on that bank decides whether to renew the facilities
or not. The tools used for monitoring are portfolio review, profitability analysis etc.

 Lack of Taking Proper Action:

Action comes after loan monitoring. Monitoring is done for identifying deviations or
exceptions. If there is any exception then corrective action needs to be taken. If corrective
actions are taken on time chance of default loan reduces. When customer misses one
installment, concerned officer of the bank must visit the customer and understand where the
problem lies. If proper action is taken, probability of loan default is reduced.

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 “The Scenario of Non-Performing loans in Bangladesh: Causes, Pitfalls and Remedies”

Macroeconomic Factors:

 Low GDP Growth:

It is evident that companies which deal in consumer products are directly affected by the
GDP growth of the entire economy. Regular customers and defaulters have opined that this
macro indicator influences the cash generation of a company and hence the repayment of the
loan.

 Increasing Crimes:
It is revealed that the effect of the increasing crimes in the business of the companies. They
think that forced subscription sometimes make the profitability of the company lower.

 Hartals by the Political Parties:

Political instability of the country hampers the production and the distribution of the products
in a smooth way and the the political turmoil is considered one of other causes of the loan
default in our country.

 Frequent Policy Changed by the Government:

Government policy is considered as the minor cause of the loan default as per our survey
since it has a little impact on the local sales and distribution of the products of the companies.
Without these are other causes such as imperfect lending practice, lack of analysis of business
risks, lack of proper valuation of security or mortgage property, undue influence by
borrowers, external pressure, loan of Govt. organization, Govt. policy for disbursement of
credit, lack of legal action.

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 “The Scenario of Non-Performing loans in Bangladesh: Causes, Pitfalls and Remedies”

2.5 Pitfalls of Non-performing loans:

A high level of non-performing assets may be a sign of financial hassle. However, it is

needed to be looked in the context of the type of lending being done. Some banks lend to
higher-risk sectors than others, and, therefore, tend to have a higher proportion of non-
performing debt. They want to get more profit by disbursing high-quantity of loan and
charging borrowers higher interest rates. A mortgage lender will almost certainly have lower
non-performing assets than a credit card lender. However, the credit card lender makes big
profit with higher spreads on the same assets, even if it eventually has to write off the non-
performing loans. So it is observed that the high-risk taker earns high profit. However, the
large numbers of NPL have a large number of side-effects.

Effect of NPL: Effects of NPL are such as Stopping Money Cycling, Earning Reduction,
Capital Erosion, Increase in Loan Pricing, Frustration etc. As a result, the values of security
are increased and the risks of financial recession also see a rise. Amplifications of the effect
of NPL are as follows:

1. NPL can lead to efficiency problem for the banking sector. It is found by a number of
economists that failing banks tend to be located far from the most-efficient frontiers, because
banks do not optimise their portfolio decisions by lending less than demanded.

2. There is a negative relationship between the non-performing loans and performance

efficiency. So, increase in NPL hampers the performing loan.

3. NPL creates the Credit Crunch situation. Credit crunch is a phenomenon that banks ration
loan disbursement and new credit commitments in order to protect, but add more risks. Credit
crunch also increases the rate of NPL.

4. There is a cyclic relation between poor economic condition and the depressed economic
growth as follows:

5. During the crisis moment, in order to restore the credibility among creditors and
depositors, failing financial institutions not only try to expand their equity bases, but also
reduce their risk assets or change the composition of the asset portfolio. Because of such
defensive actions, the corporate debtors are always targeted, thus the economic growth is
being stalled overall.

6. Money cycling gets stopped due to increase in NPL. Slow flowing of cash always has
negative impact on any business.

7. When the NPL is increased, interest earning gets stopped. But the cost of fund and the cost

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 “The Scenario of Non-Performing loans in Bangladesh: Causes, Pitfalls and Remedies”

of management are not stopped. To run the management cost along with the cost of fund, the
existing lending price has to be increased. Suddenly increased rate of interest makes hard the
return of bank money for a performing borrower.

8. NPL affects opening of LC (Letter of Credit). International importers always choose

healthy condition of the exporter's bank. Worse health condition of the bank affects the
opening of new LCs. Low rate of LCs makes low bank earning.

9. NPL exists as a natural consequence of lending behavior. When banks re-balance their
portfolio, they decide on the degree of risks they will tolerate for a given level of expected
return according to their risk preference. When the level of non-performing loans goes
beyond a certain point banks cannot accept, then it affects bank's re-balancing actions. So,
when NPLs cross the boundary of the above threshold, they start to spawn negative effects on
more lending.

There are more effects of NPL than the above, which are not observed easily. However,
causes of NPL may help us understand the NPL and take a prevention strategy.

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 “The Scenario of Non-Performing loans in Bangladesh: Causes, Pitfalls and Remedies”

2.6 Indicators of Default Loan:

 Delayed submission of financial statements

 Slowness in the ability to arrange plants visits and deterioration in the rapport
 Declining deposit balances and the occurrences of overdrafts and returned cheques
 An unusual rise in inventories and increase in trade payables
 An increase in receivables, this may indicate a lowering in the qualities of the firms
 products or services, a change in the terms of sale , or the sale to financially weak firms in
 an effort to increase sales and income
 Expansion through merger or acquisition : merger with another firm or sale of assets
 Irregular payment of the loan
 Change in management or the resignation of key personnel, labor problem
 New financial arrangement or indebtness
 Natural disasters such as flood, fire etc.

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 “The Scenario of Non-Performing loans in Bangladesh: Causes, Pitfalls and Remedies”

2.7 Strategies for remedies of non-performing loans

An increase in non-performing loan (NPL) has the multi-pronged adverse impacts on bank's
balance sheet having consequential effect of erosion of capital impairing earning streams,
profitability, liquidity and solvency. Any compromise with the quality of assets at the
sanctioning process will be a contributing factor towards enhancement of NPLs. The bank
management has no choice but to stay focused on the issue of keeping credit portfolio
performing to the maximum extent.

The total amount of default loans of 56 banks operating in Bangladesh is over Tk 546.57
billion up to June 2015.Finance Minister AMA Muhith revealed the figure in reply to a query
from MP Nurunnabi Chowdhury in Parliament on Saturday. Muhith said the state-owned
Agrani Bank, Janata Bank, Rupali Bank and Sonali Bank had accumulated bad loans of Tk
226.54 billion. The amount of default loans in 39 private banks is over Tk 227.47 billion. Of
them, Islami Bank has the highest amount of default loan at Tk 28.02 billion, which is around
six percent of its total loan. ICB Islamic Bank has the highest ratio of default loans with
77.49 percent of the total loan it disbursed turned out to be bad loans. State-owned BASIC
Bank’s default loan is 56.67 percent of its total loan, Sonali Bank 28.66 percent and
Bangladesh Commerce Bank 32.14 percent.The nine foreign banks operating in Bangladesh
have default loans of over Tk 18.39 billion. The amount of default loans in three specialised
banks – Bangladesh Development Bank, Bangladesh Krishi Bank and Rajshahi Unnayan
Bank – is over Tk 74.17 billion.
Strategies, way outs for restraining NPL:

Formulation of well-structured NPL management strategy covering following areas:

 No compromise with due diligence in the sanctioning process. Keeping in mind
"prevention is better than cure."
 Action plan for potential NPLs.
 Identification of highly risk sensitive borrowers in the credit portfolio.
 Identification of geographical area-wise risk sensitivity
 Targeting high value end NPL accounts (having exposure of Tk. 5.00 crore and above)
 Prompt action on credit reports
 Capacity building of officers and executives in the recovery department.

Goals of monitoring and follow up:

 To ensure that funds are utilized for the purpose for which they were sanctioned. To see
that the terms and conditions are complied with.
 To monitor the project implementation for avoiding time lag and consequential cost over
runs.
 To evaluate the performance in terms of production, sales, profits on a periodic basis for
ensuring that the borrower is keeping to the original plan and is having sufficient profits
to service the debts as well as for the sake of maintaining normal business momentum
 To assess the impact of negative externalities on the performance of the company.

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 “The Scenario of Non-Performing loans in Bangladesh: Causes, Pitfalls and Remedies”

 To detect the symptom of sickness at the early stage for initiating measures at the
opportune moment.
 To keep check on the movement of financial position.

Supervisory process:
 Off site Monitoring
 Periodic reports on the risk sensitive clients/ borrowers
 Analysis of financial statement to find out the weaknesses in the business
 Risk grading
 On site Monitoring
 Physical visits to the business venue of the clients.
 Direct interaction/discussion meeting
 Preventive measures:
 Understand client's business
 Analyze client's financials
 Frequent visits to client
 Ensuring perfection of legal documentation
 Investigation on market rumors
 Use Credit Bureau checkings

Supervision and follow-up of advances can be divided into three main control groups:

1. Legal control
 Proper execution of documents
 Keeping the documents constantly in force.
 Complying with various legal formalities like:
 Registration of charges
 Creation of mortgage
 Complying with the directives of the central bank and internal policy guidelines

2. Physical control
 Inspection of the physical securities charged in favor of the bank.
 Verification of books of accounts
 Cross checking with the physical securities
 Inspection of factory and go down sites/premises to ascertain the activity levels and
stock levels respectively

3. Financial control
 Evaluating the performance of the company on the basis of periodic financial
statements.
 Monitoring the utilization of limits through quarterly information statement and
monthly select operational data.

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 “The Scenario of Non-Performing loans in Bangladesh: Causes, Pitfalls and Remedies”

 The credit inspection and supervision pertaining to the account could be off site or on
site.
 Off site supervision is generally done at bank's desk level.

Steps for recovering bank's funds from a problem loan:

 Bankers must always keep the goal of loan workouts firmly taking into consideration the
worst case scenario.
 The rapid detection and reporting of any problem with a loan are essential; delay often
worsens a problem loan situation.
 The loan workout responsibility should be separate from the lending function to avoid
possible conflict of interest.
 The concerned credit officer should confer/discuss with the troubled borrower quickly on
possible options especially for cutting expenses, increasing cash flow and improving
management control. Develop a preliminary plan of action after determining the bank's
risk exposure and sufficiency of loan documents, especially any claim against customers
collateral other than that held by the bank.
 Estimate what resources are available to collect the troubled loan including the estimated
liquidation values of assets and deposits.
 The bank's credit personnel must evaluate the quality, competence and integrity of the
current management and visit the site to assess the borrower's property and operations.
 Bank's concerned credit specialist must consider all reasonable alternatives for cleaning
up the troubled loan, including making a new, temporary agreement if loan problems
appear to be short term in nature or finding a way to help/ cooption of strategic partner
the customer strengthen cash flow or to inject new capital in to the business. Other
possibilities include finding additional collateral, securing guarantees/undertaking/ to
initiate the case of foreclosure.

Rescheduling of NPLs:
Bangladesh Bank in its recent circular vide 08 dated 14.06.2012 has expressed overriding
concern over the propensity of prolongation by even renewal of term loan/ extension of
validity arbitrarily which has been termed as prolongation/ ever greening may sometime
result in over statement of capital, higher end maintenance of provisions than required though
having low probability of repayment but carries full value on bank's balance sheet.
To curb this propensity Bangladesh Bank prescribed following instructions in the
consideration process of loan rescheduling:
 The bank must have a policy approved by its Board defining the circumstances/
conditions under which a loan may be rescheduled but not in contravention of the
contents of the Bangladesh Bank circular. The policy must highlight the controlling
mechanisms for avoidance of routine rescheduling/ repeat rescheduling wherein lies the
doubt of recovery of full amount of loan.
 For the unproductive sector such kind of repeat rescheduling should be restricted.

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 “The Scenario of Non-Performing loans in Bangladesh: Causes, Pitfalls and Remedies”

 The bank must identify the causes behind the loan becoming non performing.
 No consideration will be accorded for rescheduling of the borrower who is a habitual loan
defaulters rather legal action should be initiated for recovery.
 At the time of applying rescheduling down payment to be realized at a time in cash.
 While considering the rescheduling proposal overall repayment capability of the borrower
to be assessed properly.
 If a bank is satisfied in the due diligence process that there exists acceptable
circumstances for rescheduling and the concern/ borrower has the ability to generate
required cash flow for repayment in that case rescheduling proposal to be considered
positively.
 Rescheduling of any loan must be justified in right perspective and its positive impacts on
the bank's credit portfolio/ long term profitability, capital adequacy, liquidity etc.

Legal Proceedings:
In all commercial loan default filing of money suit with the appropriate court of law under the
relevant section is the ultimate recourse which should be taken to when all other actions have
failed to elicit any result.
Unless the borrower is notoriously recalcitrant and ill motivated and if there is the possibility
of recovery when some easy terms are offered in that case Banks should try to rehabilitate the
borrower by reviving the business instead of filing of suit.

Under the following circumstances the bankers are generally inclined to file suit as a last
resort:

 The borrower has failed to repay anything against the dues and also failed to respond to
any notice of the Bank to repay.
 The borrower has continuously given false hopes to the bank that he is going to pay off
immediately but never has paid and created instances of breach of commitment
repeatedly.
 Where some fraud /forgery has been committed and no avenue is open to negotiate with
the borrower for repayment of the loan.
 The bankers should utilize all the available avenues for alternate dispute resolution/
amicable settlement even after filing suit against the borrower on best effort basis.

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 “The Scenario of Non-Performing loans in Bangladesh: Causes, Pitfalls and Remedies”

Part 3: Conclusive part

3.1 Findings:

Findings of NPL are such as Stopping Money Cycling, Earning Reduction, Capital Erosion,
Increase in Loan Pricing, Frustration etc. As a result, the values of security are increased and
the risks of financial recession also see a rise. Amplifications of the effect of NPL are as
follows:
 NPL can lead to efficiency problem for the banking sector.
 There is a negative relationship between the non-performing loans and performance
efficiency. So, increase in NPL hampers the performing loan. Most of the cases, it occurs
when there is an adverse selection.
 NPL creates the Credit Crunch situation. Credit crunch is a phenomenon that banks ration
loan disbursement and new credit commitments in order to protect, but add more risks.
Banks treat loan as an asset. They expect return from it. If loans become NPLs then banks
have lack of fund to give loan according their commitment or banks could give loans at
their previous interest rate. Clients have to pay more. So loans may be defaulted. Credit
crunch also increases the rate of NPL.
 When the NPL is increased, interest earning gets stopped. But the cost of fund and the
cost of management are not stopped. To run the management cost along with the cost of
fund, the existing lending price has to be increased. Suddenly increased rate of interest
makes hard the return of bank money for a new borrower. So rate of investment will be
lower.
 NPL affects opening of LC (Letter of Credit). International importers always choose
healthy condition of the exporter's bank. Worse health condition of the bank affects the
opening of new LCs. Low rate of LCs makes low bank earning.
 If the risk is high, banks will expect high return. When the level of non-performing loans
goes beyond a certain point banks cannot accept, and then it affects bank's re-balancing
actions. So, when NPLs cross the boundary of the above threshold, they start to spawn
negative effects on more lending.
 NPL has a positive relationship with interest rate. When NPL increases, loan which is
treaded as asset becomes more risky. So that the rate of interest also increases to get
sufficient retune from the loan to cover the risk.

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 “The Scenario of Non-Performing loans in Bangladesh: Causes, Pitfalls and Remedies”

3.2 Recommendation

No compromise with due diligence in the sanctioning process. Keeping in mind "prevention
is better than cure."Banks should take high collateral. If a borrower defaults on a loan, the
lender can sell the collateral and use the proceeds to make up for the loss. The security or
collateral provided must be valued by proper agency or put up on a regular ‘mark to market’
valuation process.
 Action plan for potential NPLs. Banks should have some step to collect the NPLs loan. At
the end banks should go to Artha Rin Adalat.
 Identification of highly risk sensitive borrowers in the credit portfolio. Banks should take
information about the clients before giving loans. Banks could go Bangladesh Bank to
collect the information and verify the financial statement carefully from reliable sources
to identify the risky borrowers.
 Identification of geographical area-wise risk sensitivity. Banks should identify the clients
according area wise that’s mean in Bangladesh, there is some places where growth rate is
low or rate of repay rate is low.
 Targeting high value end NPL accounts (having exposure of Tk. 5.00 crore and above)
 Prompt action on credit reports.
 Capacity building of officers and executives in the recovery department. Banks should
give proper training to employee. So they can handle loans properly. If there is short of
experience employee, bank should recruit experience employee for recovery department.

A healthy risk management culture, with a ‘well articulated’ risk management policy can help
the institutions to avoid such loan default.

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 “The Scenario of Non-Performing loans in Bangladesh: Causes, Pitfalls and Remedies”

3.3 Conclusion

More than 20 years have passed since the adoption of prudential norms in the banking system
of Bangladesh in 1990. Unfortunately, the banking system is still burdened with an alarming
amount of NPLs and lags far behind the neighboring countries of India and Sri Lanka.
Although Bangladesh has to a large degree adopted international standards of loan
classification and provisioning, the management of NPLs is found ineffective, as the system
has failed to arrest fresh NPLs significantly. It needs to be mentioned that management of
NPLs must be multi-pronged, with different strategies pursued at the different stages through
which a credit facility passes. Measures should be in place for both prevention and resolution.
With regard to preventive measures, emphasis needs to be placed on credit screening, loan
surveillance and loan review functionaries both at individual bank levels and in the central
bank of the country. Resolution measures must be accompanied by legal measures, i.e.
improving the efficiency of the legal and the judicial system and developing other out of the
court settlement measures like compromise settlement schemes, incentive packaging,
formation of asset management companies, factoring, and asset securitization and so on.
Unfortunately, Bangladesh is found to be very weak from the above point of view, and
strictly speaking, it has mainly concentrated on a few legal measures that have also been
found to be ineffective.

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 “The Scenario of Non-Performing loans in Bangladesh: Causes, Pitfalls and Remedies”

3.4 Reference

Books:

 “Commercial bank Management” and “Bank Management and Financial Services” by

Peter S. Rose.

Websites:
 www.Investopedia .com
 www.wikipedia.com
 www.ask.com
 www.bangladesh-bank.org
 www.Financialexpress.bd.com
 www.scribd.com
 www.assignmentpoint.com

Article/Report of Authorities
 Asian Development Bank.
 Bangladesh Bank.
 Bangladesh Institute of Bank Management (BIBM).
 Banking Regulation and Policy Department, Bangladesh Bank.

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