Non-performing Loans in Banking Sector ofBangladesh Causes and Effect

Submitted to:Sk. Alamgir HossainLecturerDept. of FinanceJagannath University, Dhaka.

Submitted by: Md. Abdullah Al Masum MBA ID. M130203055

Session: 2013-14 Dept. of Finance

Jagannath University, Dhaka.

Table of Contents

Serial No. Topics Page No.Letter of transmittalAcknowledgementExecutive SummaryChapter – 1 Introduction

1.1 Objective of the Study1.2 Methodology of the Study1.3 Limitations of the Study

Chapter-2 Literature ReviewChapter – 3 Banking industries of Bangladesh

3.13.23.3 Strategic Objectives3.4 Ethical Standards

Chapter – 4 Definition of NPL4.1 Classified Loan4.2 Non Performing Loan in BD4.2.1 Base for Provisioning and accounting treatment of NPLs4.2.2 Trend of Loan Default Problem in Bangladesh4.2.3 The Present status of Loan Defaults Culture in Bangladesh4.2.4 Present Status of Non-performing Loans 4.3 Causes Of Non Performing Loans

Chapter – 5 Analytical Part5.1 Descriptive Analysis5.2 Multiple Regression Analysis

Chapter – 6 Findings, Recommendation & Conclusion6.1 Findings6.2 Recommendation6.3 Conclusion

Appendix

List of tables

Name of Tables Page no.Table-1 Banking industries of BangladeshTable-2 Contribution of Banking sector in National ImportTable-3 National and Agrani Bank Limited’s Export PerformanceTable-4 Country wise remittance of Banking sectorTable-5 Data AnalysisTable-6 Income from Export, Import and Remittance comparison with Net IncomeTable-7 Amount of Export, Import, Remittance and Net Income

Letter of Submission

3rd Septeber, 2015ToSK. Alamgir HossainLecturerDepartment of FinanceJagannath University, Dhaka.

Subject: Submission of internship report.

Dear Sir,

It is my great pleasure to submit the report on NPLS in Banking Industry of Bangladesh: Causes and Effects that you have assigned me. It has been a great experience for me to prepare a report. 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 RegardsYours Faithfully

…………………………...Md. Abdullah Al MasumMBA Program (4th Batch)Roll No. M130203055, Reg. No. 1001335292Department of FinanceJagannath University, Dhaka

Supervisor’s Certification

This is to certify that Md. Abdullah Al Masum is a student of MBA (Finance), Jagannath University bearing ID No: M130203055. He has completed his Internship Report entitled “NPLS in Banking Industry of Bangladesh: Causes and Effects”. He has completed the Internship report under my supervision for the partial fulfilment of the award of MBA (Finance) degree.

As far as I know he tried his best to conduct this report successfully. I think this study will help him in the future to build up his career.

I wish his every success in life.

With best wishes & regards

…………………………………....

SK. Alamgir HossainLecturer,Department of FinanceJagannath University, Dhaka

Declaration

I affirmed that the Internship report titled Non-performing Loans in Banking Sector in Bangladesh being submitted for the internship part of MBA program is the original work carried out by me. I further declare that this Internship report is based on my original work and no part of this project has been published or submitted to anybody.

Thanks and RegardsYours Faithfully

………………………............

Md. Abdullah Al Masum

MBA Program (4th Batch)Roll No. M130203055Reg. No. 1001335292Department of FinanceJagannath University Dhaka

Acknowledgement

The report on “Nonperforming Loans in Banking Sector of Bangladesh: Causes and Effects” has been prepared to fulfill the requirements of MBA degree. I am very much fortunate that I have received sincere guidance, supervision and co-operation from various respected people while preparing this report. At the very beginning I would like to express my gratitude to God for special blessing in completing the report. Then, I would like to thank my academic supervisor of the Internship Program SK. Alamgir Hossain, Lecturer,Department of Finance ,Jagannath University, Dhaka for giving me the opportunity to prepare this report. He also provided me some important advices and guidance for preparing this report. Without his assistance, this report would not be a comprehensive one.

………………………….

Md. Abdullah Al Masum

MBA Program (4th Batch)Roll No. M130203055Reg. No. 1001335292Department of FinanceJagannath University Dhaka

Abbreviation

AD = Authorized Dealer BLC = Bills under letter of Credit CC = Cash Credit DPS = Deposit Pension Scheme ERC = Export Registration Certificate FDD = Foreign Demand Draft L/C = Letter of Credit LTR = Loan against Trust Receipt PF = Provident Fund HBL = House Building Loan OD = Overdraft DL = Demand Loan CLS = Consumer Loan Scheme

Executive SummaryNonperforming 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.

Chapter -1Introduction

Smooth and efficient flow of saving-investment process is a prerequisite for the e c onomic

development of a country. Bangladesh, being a developing country and with an underdeveloped

capital market, mainly depends on the intermediary role of commercial banks for mobilizing

internal saving and providing capital to the investor. Thus, it matters greatly how well our

financial sector is functioning. Looking at the performance of our financial sector for the last

decade or so, we observe that our banking sector is heavily burdened with a high percentage of

non-performing loans (NPLs).

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.

1.1. Objective of the Study

The objectives of this paper are

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

ii. To show the trend of the “loan default problem’’ in Bangladesh.

iii. To examine the loan default status of commercial banks.

iv. To discuss legal aspect to recover loans from the defaulters.

v. To identify the causes and remedies of non-performing loans and.

vi. To raise some issues and observations which need to be looked upon quickly for ensuring a

financially sound banking sector.

1.2. Meth od ology of Study:

The research methodology of the study has been enumerated below:

Sources of Data and Data Collection:

Data has been collected from the various secondary sources like research works of individuals,

different publications, journal of different institutions, Bangladesh Bank Credit Risk Grading

manual , Bangladesh Bank annual report etc.

1.3. Limitations of the study:

The limitations of the study are

1. This study did not cover primary and unpublished data.

2. The major problem faced while conducting the research was unavailability of relevant data.

3. Time constraint.

Chapter – 2Literature Review:

Non-performing loans refer to those financial assets from which banks no longer receive interest or

installment payments as scheduled. It is a very critical but frequent issue in bank fund management and the

present situation of NPLs in Bangladesh is a topic of great concern. It can bring down investors’

confidence and if created by the borrowers willingly and left unresolved might act as a contagious

financial malaise by driving good borrowers out of the financial market. The volume of default loans of

state owned commercial banks in Bangladesh (BD) has been increasing at an alarming rate. It is not a new

issue but the tendency of fraud, embezzlement and loan default is in a serious situation in recent years due

to excessive political interference and illegal interruption of the concerns. The amount of total NPLs in the

banking system of BD was Tk 523.1 billion at the mid of 2014, which was Tk 427.3 billion in 2013 and 200.1

billion in 2007. The amount doubled within 8 years. For last 8 years, loan default as a percentage of

outstanding loans in state owned commercial banks was 50% or above where Private commercial banks and

foreign commercial banks and hold maximum 5-10 % amount of the total. If the scam series continues

then it may put the entire banking sector in an embarrassing situation with the increase of Non-Performing

loan in an alarming rate. Bangladesh Bank has given ultimatum to 11 local and foreign banks to bring down

their soaring non-performing loans to below 10 per cent of their respective outstanding loans .

Lending decision of a bank is very important because it determine the future profitability and performance of

the bank. Recently banks are becoming more and more conscious in customer selection to avoid the

negative impact of bad loan or non-performing loan. The issue of nonperforming loans (NPLs) has gained

increasing attentions in the last few decades. Amounts of bad loans are alarmingly increasing in not only the

developing and under developed countries but also in developed countries. Banks’ lending policy could have

crucial influence on non-performing loans. A default is not entirely an irrational decision. Rather a defaulter

takes into account probabilistic assessment of various costs and benefits of his decision. Lazy banking’

critically reflects on banks’ investment portfolio and lending policy (Reddy & Mohan (2003); Sinkey

(1991) & Dash (2010) sector. According to the definition of the Financial Reconstruction Law (FRL), the

total amount of NPLs of all banks in Japan as of the end of March 2003 was 35.3 trillion yen, although there

are claims that the actual amount of NPLs might exceed 100 trillion yen. On the other hand, the causes of the

financial and exchange rate crisis that erupted in East Asia (Thailand, Taiwan, Malaysia and Indonesia) in

1997 are viewed as high short-term external debts, excessive loans for real estate, large current account

deposits, high international interest rates and weaknesses in the balance sheet of financial institutions. In

addition, Kwack (2000: 195-206) finds that the 3-month LIBOR interest rate and nonperforming loan rates

of banks were the major determinants of the Asian financial crisis. Huang and Yang (1998: 11) report that

unlike the other countries of East Asia, China did not face financial fragility because of the size of its foreign

exchange reserve, its current account surplus, the dominance of foreign direct investment in capital flows and

the control of the capital account. As of June 2003, China recorded only 5.68% of its total loans as

nonperforming while, in contrast, Thailand, Indonesia, Philippines and Malaysia record NPLs at 15.29%, 8%,

15% and 8.7% respectively. Unfortunately, the present (December, 2005) rate of NPLs in China has

increased to 8.6%.

In the Indian subcontinent (India, Pakistan, Sri Lanka, Bangladesh and Nepal), however, the causes of

nonperforming loans are usually attributed to the lack of effective monitoring and supervision on the part of

banks (as required by the BASEL principles of bank monitoring and supervisions), lack of effective lenders’

recourse, weaknesses of legal infrastructure, and lack of effective debt recovery strategies. Among the

countries in the Indian sub-continent, the rate of NPLs as a percentage of total loans disbursed in 2005 is seen

to be minimal in India (5.2%), followed by Sri Lanka (9.6%). Bangladesh, however, still records a staggering

rate of 13.56%.

Chapter -3

3.1 History of Banking Industry in Bangladesh :

After the independence, banking industry in Bangladesh started its journey with 6 Nationalized

commercialized banks, 2 State owned Specialized banks and 3 Foreign Banks. In the 1980s

banking industry achieved significant expansion with the entrance of private banks. Now, banks

in Bangladesh are primarily of two types:

Scheduled Banks: The banks which get license to operate under Bank Company Act, 1991

(Amended in 2003) are termed as Scheduled Banks.State-owned commercial banks, private

commercial banks, Islamic commercial banks, foreign commercial banks and some specialized

banks are Scheduled Banks.

Non-Scheduled Banks: The banks which are established for special and definite objective and

operate under the acts that are enacted for meeting up those objectives, are termed as Non-

Scheduled Banks. These banks cannot perform all functions of scheduled banks. Grameen Bank,

Probashi Kallyan Bank, Karmasangsthan Bank, Progoti Co-operative Land Development Bank

Limited (progoti Bank) and Answer VDP Unnayan Bank are Non-Scheduled Banks.

Non-banking financial institutions which are not banks.These institutions cannot perform all

functions of banks, which get license to operate under Financial Institution Act, 1993 are termed

as Non-banking financial institutions.

3.2 List of commercial Banks

State-owned Commercial Banks

1. Sonali Bank Limited

2. Janata Bank Limited

3. Agrani Bank Limited

4. Rupali Bank Limited

5. BASIC Bank Limited

6. BDBL (Bangladesh Development Bank Limited)

State-owned Specialized Banks

1. Rajsahi Krishi Unnoyon Bank (RKUB)

2. Bangladesh Krishi Bank Limited

Private commercial Bank

Private banks are the highest growth sector due to the dismal performances of government banks

(above). They tend to offer better service and products. Here is the list:

1. AB Bank Limited

2. Bangladesh Commerce Bank Limited

3. Bank Asia Limited

4. BRAC Bank Limited

5. Dhaka Bank Limited

6. Dutch Bangla Bank Limited

7. Eastern Bank Limited

8. IFIC Bank Limited

9. Jamuna Bank Limited

10.Meghna Bank Limited

11.Mercantile Bank Limited

12.Midland Bank Limited

13.Modhumoti Bank Limited

14.Mutual Trust Bank Limited

15.National Bank Limited

16.NCC Bank Limited

17.NRB Bank Limited

18.NRB Commercial Bank Limited

19.NRB Global Bank Limited

20.One Bank Limited

21.Prime Bank Limited

22.Pubali Bank Limited

23.Simanto Bank Limited (proposed)

24.South Bangla Agriculture and Commerce Bank Limited (www.sbacbank.com)

25.Southeast Bank Limited

26.Standard Bank Limited

27.The City Bank Limited

28.The Farmers Bank Limited

29.The Premier Bank Limited

30.Trust Bank Limited

31.United Commercial Bank Limited

32.Uttara Bank Limited

There are eight private Islamic Commercial Banks in Bangladesh:

1. Islami Bank Bangladesh Limited

2. Al-Arafah Islami Bank Limited

3. Export Import Bank of Bangladesh Limited

4. Social Islami Bank Limited

5. Shahjalal islami Bank Limited

6. First Security Islami Bank Limited

7. Union Bank Limited

8. ICB Islamic Bank Limited

Foreign Commercial Banks

There are nine foreign commercial banks currently operating in Bangladesh. These are:

1. Bank Al-Falah

2. Citibank NA

3. Commercial Bank of Ceylon

4. Habib Bank Limited

5. HSBC (The Hong Kong and Shanghai Banking Corporation Ltd.)

6. National Bank of Pakistan

7. Standard Chartered Bank

8. State Bank of India

9. Woori Bank

Specialized Banks

Specialized banks were established for specific objectives like agricultural or industrial

development. These banks are also fully or majorly owned by the Government of Bangladesh.

1. Bangladesh Development Bank Limited

2. Bangladesh Krishi Bank

3. Rajshahi Krishi Unnayan Bank

4. Karmasangsthan Bank

5. Probashi Kallyan Bank

6. Palli Sanchay Bank

7. Grameen Bank

8. Ansar-VDP Unnayan Bank

9. Bangladesh Samabaya Bank Ltd

10.The Dhaka Mercantile co-operative Bank Ltd

11.Progoti Co-operative Land Development Bank Limited (Progoti Bank)

NPSB member Banks

1. AB Bank Limited

2. Al-Arafah Islami Bank Limited

3. Bangladesh Krishibank

4. Bank Asia Limited

5. BASIC Bank Limited

6. BRAC Bank Limited

7. Dutch-Bangla Bank Limited

8. Eastern Bank Limited

9. EXIM Bank Limited

10. First Security Islami Bank Limited

11. ICB Islamic Bank Limited

12. IFIC Bank Limited

13. Islami Bank Bangladesh Limited

14. Jamuna Bank Limited

15. Meghna Bank Llimited

16. Mercantile Bank Limited

17. Midland Bank Limited

18. Modhumoti Bank Limited

19. Mutual Trust Bank Limited

20. National Bank Limited

21. NRB Bank Limited

22. NRB Commercial Bank Ltd

23. NRB Global Bank Limited

24. One Bank Limited

25. Prime Bank Limited

26. Pubali Bank Limited

27. SBAC Bank Limited

28. Shahjalal Islami Bank Limited

29. Social Islami Bank Limited

30. Sonali Bank Limited

31. Southeast Bank Limited

32. Standard Bank Limited

33. Standard Chartered Bank Limited

34. The City Bank Limited

35. Trust Bank Limited

36. Union Bank Limited

37. United Commercial Bank Limited

38. Uttara Bank Limited

39. Agrani Bank Limited

40. Habib Bank Limited

Non-banking financial Institutions

1. Investment Corporation of Bangladesh (ICB)

2. Uttara Finance and Investments Limited

3. United Leasing Company Limited

4. Union Capital Limited

5. The UAE-Bangladesh Investment Company Limited

6. Saudi-Bangladesh Industrial & Agricultural Investment Company Limited (SABINCO)

7. Reliance Finance Limited

8. Prime Finance & Investment Limited

9. Premier Leasing & Finance Limited

10.Phoenix Finance and Investments Limited

11.People's Leasing and Financial Services Limited

12.National Housing Finance and Investments Limited

13.National Finance Limited

14.MIDAS Financing Limited

15.LankaBangla Finance Limited

16.Islamic Finance and Investment Limited

17.International Leasing and Financial Services Limited

18.Infrastructure Development Company Limited (IDCOL)

19.Industrial Promotion and Development Company of BangladeshLimited (IPDC)

20.Industrial and Infrastructure Development Finance Company (IIDFC) Limited

21.IDLC Finance Limited

22.SUMON Bank

23.Hajj Finance Company Limited

24.GSP Finance Company (Bangladesh) Limited (GSPB)

25.Firt Lease Finance & Investment Limited

26.FAS Finance & Investment Limited

27.Fareast Finance & Investment Limited

28.Delta Brac Housing Finance Corporation Limited (DBH)

29.Bay Leasing & Investment Limited

30.Bangladesh Industrial Finance Company Limited (BIFC)

31.Bangladesh Finance & Investment Company Limited

32.Agrani SME Finance Company Limited

33.CAPM Venture Capital and Finance Limited

34.Meridian Finance and Investment Limited

35.Realistic Finance Bank Limited

Chapter -44.1Definition of Nonperforming Loans (NPLs):

A Non-performing loan is a l o an th at is in d e fa ult or close to being in default. Many loans

become non-performing after being in default for 90 days, but this can depend on the con t ract

terms.

According to IMF, definition of NPLs

is

“A loan is nonperforming when payments of interest and principal are past due by 90 days or

more, or at least 90 days of interest payments have been capitalized, 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” (Wikipedia, definition of NPLs).By bank regulatory

definition non-performing loans consist of:

• Loans that are 90 days or more past due and still accruing interest, and

• Loans which have been placed on nonaccrual (i.e., loans for which interest is no longer

accrued and posted to the income statement).

Loan may also be non- performing if it is used in a different way than that for which it has

been taken. As per Section 5 (cc) of Bank Company Act 1991, 'defaulting debtor' means any

person or institution served with advance, loan granted in favor 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. 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 .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.

C la s s i f i ed L oa n :

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 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.

4.2 Nonperforming Loan in Bangladesh:

The issue of nonperforming loans in Bangladesh is not a new phenomenon. In fact, the seeds

were cultivated during the early stage of the liberation period (1972-1981), by the government’s

“expansion of credit” policies on the one hand and a feeble and in firm banking infrastructure

combined with an unskilled work force on the other. The expansion of credit policy during the

early stage of liberation, which was directed to disbursement of credit on relatively easier terms,

did actually expand credit in the economy on nominal terms. However, it also generated a large

number of willful defaulters in the background who, later on, diminished the financial health of

banks through the “sick industry syndrome”. Despite the liberalizing and privatizing of the

banking sectors in the 1980s with a view to increasing efficiency and competition, the robustness

of the credit environment deteriorated further because of the lack of effective lenders’ recourse

on borrowers. Government direction towards nationalized commercial banks to lend to

unprofitable state owned enterprises, limited policy guidelines (banks were allowed to classify

their assets at their own judgments) regarding “loan classification and provisioning”, and the use

of accrual policies of accounting for recording interest income of NPLs resulted in alignments of

the credit discipline of the country till the end of 1989.

In the 1990s, however, a broad based financial measure was undertaken in the name of FSRP,

enlisting the help of World Bank to restore financial discipline to the country. Since then, the

banking sector has adopted “prudential norms” for loan classification and provisioning. Other

laws, regulations and instruments such as loan ledger account, lending risk analysis manual,

performance planning system, interest rate deregulation, the Money Loan Court Act 1990 have

also been enacted to promote sound, robust and resilient banking practice. Surprisingly, even

after so many measures, the banking system of Bangladesh is yet to free itself from the grip of

the NPL debacle. The present study has concentrated on the above issues mainly with a view to

assisting policymakers to formulate concrete measures regarding sound management of NPLs in

Bangladesh.

4.2.1. Base for provisioning and accounting treatment of NPLs:

A balance sheet item representing funds set aside by a company to pay for losses that are

anticipated to occur in the future. The actual losses for the earmarked funds have not yet

occurred, but the general provisions account is counted as an asset on the balance sheet.

The bank managers of Bangladesh deduct the amount of interest suspended and the value of

“eligible securities” from the outstanding amount in order to determine the base for provisioning

to NPLs. For unclassified loans, however, they keep a general provision (1%) against the

outstanding amount and include it in the capital to determine the capital adequacy of the bank (at

present 10%). With regard to income recognition, bank managers do not consider the amount of

interest on substandard and doubtful loans as income for the bank, but rather keep it separately in

an “interest suspense account”. However, if any amount is received against sub-standard and

doubtful loans, the said amount is deducted from the total interest suspense amount. In the case

of a bad/loss loan, the interest on such loan is also kept in the interest suspense account if a suit

is filed in the court. Seemingly, with regard to substandard and doubtful loans, this interest is

also excluded from the income of the bank. These accounting measures have made the banking

sector more transparent and credible than they were in the past.(Marge with provision) .

4.2.2 Trend of the Loan Default Problem in Bangladesh

Emergence of Default Loans

As banking remains the main intermediary vehicle of harnessing investible capital for

accelerating the growth of the productive sectors in Bangladesh, the continuing crisis of

accumulation of non-performing and defaulted banks loans has emerged as one of the most

serious constraints in the path of economic development of our country. Now we will discuss

how the loan default problem has emerged in our country by year-wise.

Post liberation period

After the liberation of Bangladesh, the Awami League Government’s decision to nationalize the

banks and insurance companies operating in Bangladesh should be considered a logical step but

the task of re-organization of the nationalized banks in the chaotic, war-ravaged and crisis-ridden

post-liberation years and a very rapid expansion of banking network in rural Bangladesh created

some problems for the banking sector. There was no time after nationalization as the most

corrupt, undisciplined, over manned and mismanaged concerns mired in sea of recurrent losses

in the backdrop of the political and administrative inexperience of the post liberation regime.

In this scenario, the nationalized banks were involved in two sorts of pressure situations, firstly,

the almost insatiable demand for credit from the loss making state-owned enterprises kept the

banks under constant pressure due to a shortage of adequate liquidity and secondly the newly

emerging so called “briefcase business man” with connection with politics and politicians, top

bureaucrats and top bankers, and retired military and civil bureaucrats were constantly lobbing

for access to bank credit and in the process were vitiating the work atmosphere in the banks by

alluring a section of the banker to indulge in corruption and malpractices. It is now widely

recognized that today’s millionaires of Bangladesh came mostly from the Ranks of those

“briefcase businessman” and the groups mentioned, who could successfully establish and

maintain this types of patron clients relationship with the bankers and in the process created a

host of millionaires from amongst those bankers themselves, who had actively connived and

harvested the illicit margins in exchange of the favors rationed out to those fortunate loaners.

The political changes of 1975 ushered in an era of political culture, where in corruption gradually

became institutionalized; the economics of rent seeking took firm roots in the body politic of

Bangladesh. In the process, sanctioning of bank loans became one of the prime victims of the

buying and selling process afflicting the political party affiliation process, and a popular

mechanism for doling out financial favors to party leaders as well as political cadres. This

politicization of the banking practices has seriously hampered the institutional disciplines of the

banks, where professional expertise, integrity and ethical values have become exceptions to some

extent rather than rules. Ex-banker emerged as financiers as the newly floated private banks, but

there was no mechanism to make them accountable or to know about the sources of their cash.

Defaulters of bank loans taken from nationalized banks or state-owned development finance

institutions swelled the rank of directors of the newly established private banks, but nobody

intervened on behalf of the loan-giving banks caught in the middle with defaulted loans. The

laws, rules and regulations relating to banking remained mostly in the books; and the judicial

process utterly failed to take the willful defaulters to task, thereby making the process of lender’s

recourse on borrowers almost a mockery in Bangladesh. Therefore, we surmise that behind all

these malaises, the nature of the state and of politics played the real villainous role by

patronizing and developing a class of ‘comprador bourgeoisie’ in Bangladesh, created, nursed

and constantly nourished by state-patronage, and in this nursing process, bank loans were

rampantly used as lucrative doles.

In the eighties, the rapid liberalization of Bangladesh’s import regime has created the so-called

‘sick-industry syndrome’, which provided a potent excuse for some, and created genuine

hardships regarding repayment of bank loans for the other. The domestic industries have been

bearing the brunt of this ill-advisedly too rapid pace of liberalization of Bangladesh’s

international trade without appropriate preparatory policy measures. The political doldrums of

the late-eighties provided additional excuses to these swelling groups of defaulters. The BNP

government of 1991-96 tried to stem the rot in this field in the initial years of its term. They

repeated the blunders of its predecessor of providing lavish encouragement to bank managements

to ease and expedite the process of term lending, especially according to its own political

exigencies at the later stated of its rule, which added a massive amount of fuel to the fire of the

so-called ‘default-culture. And earlier lending sprees continues to haunt the banking section even

today be sustaining the momentum of the build-up of the defaulted loans of the earlier two

decades.

4.2.3. 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.

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

(in crore)

Bank Name Defaulted Loan as of Sept 31, 2014

Defaulted Loan as of Dec 31, 2014

Defaulted Loan as of March 31, 2015

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

4.2.4. 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).

4.3 Causes of Nonperforming Loans

A. ENTREPRENEURS RELATED

A1: 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 here 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.

A2: 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 of 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.

A3: 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 repay the loans.

A4: Lack of Supporting Facilities

Sometimes business need support from other sources like government authority. 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.

B: BUSINESS RELATED

B1: Non-attractive Industry

Sometimes non-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 no

non-attractive industry perform poor. For example: suppose in Bangladesh Jute industry is one of

the non –attractive industries. Now any investor want to invest in this sector may be cause loss.

So this investor can’t pay the interest.

B2: 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.

B3: Poor Management capability

Before sanctioning a loan banks look into 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 vital role in repaying bank loan. The more professional the

management is, the less is the probability of defaulting loan.

B4: Poor Financial Performance

Definitely poor financial performance is the most important cause of loan default. Once a

company is not solvent, it is unlikely 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.

B5: 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 on credit. So it may not have enough

cash to support the loan and other debts. So it may cause default.

B6: 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. Operating in a niche market, having a very low market share

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

earning. But operating in niche product in a market which is not proper or have fewer customers

that it expected then it cannot be profitable. So it cannot pay its interest payment.

C: LENDING RELATED

C1: 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.

C2: 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.

C3: Lack of Proper Monitoring

Monitoring is one of the most important parts for financial institutions. 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 reviews, profitability analysis etc. before diverse loan, Banks

can check the credit rating of the organization. Banks can generate information about borrowers

from Bangladesh Bank. Then banks can decide how much money investor needs and how much

money he will be invested. Valuation culture of the security or collateral is absent in many of

banks.

C4: 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

D: MACROECONOMIC FACTORS

D1: 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.

D2: 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.

D3: 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 political turmoil is considered one of the other causes of the loan default in

our country.

D4: Frequent polity Changed by the Government

Government is considered as the minor cause of the loan default as per the survey since it has a

little impact on the local sales and distribution of the products of the companies. For example: in

this budget government increase tax on mobile phones which are imported from foreign country,

so mobile phone importer may not generate expected revenue. So importer could not par their

interest payment. So they could be defaulter. 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 go Govt. organization,

Govt. policy for disbursement of credit, lack of legal action.

Name of firm Approved Types of Loan Year of Expiry ReasonLoan Disbursement

Samam Trade 01 Crore Term Loan for 2011 2014It is a trading firm. It imports Locker from

International 3 yearschina through issuing L/C. From Oct’13-Jan’14 the firm didn’t open any L/C, dueto political unrest. It happened because thefirm had enough stock in its warehouse,but due to strike it could not sell its goods,as a result the firm got stuck in fundshortage. On the contrary, the firm has alimit of fund for importing goods. Due tononpayment of loan that created problemagainst Import process, the outstanding ofthe loans were getting higher. At the endof November’13 the client listed as SMA,And In March’14 the loan declared BadLoan.Causes :1. Hartals by the Political Parties:Due to strike, firm did not performaccording their plan. So they can notgenerate enough revenue to pay theinterest payment.

2. Poor Financial Performance:lack of proper strategy for strike. SoIt cannot generate revenue.

Swadesh Steel 50 Lac OD loan 2013 2014

The client is a local supplier of rod, angel

revolving

bar etc. It approached the loan to allow aOD limit of 80 Lac. The bank approved 50Lac for extension of its operation. But theproprietor‘s intention was mischievous.Instead of investing the fund into businessthe owner purchased Land in Savar. Justafter 3 month of disbursement the client’stransaction became irregular. The banktried to make the client pay the outstandings. But the client’s business wasnot capable of to pay the proceeds onregular basis. After 1 year the Loanbecame Bad Loan. The Bank is trying torecover the amount.Cause:

1. Lack of Proper Monitoring:Bank should take information aboutthe client before approve loan.

2. Unwillingness to Pay:The client intension was not good.May be bank kept low collateral sothat he thought that it will not harmhim a lot.3. Mis use of fund: Client use thefund to buy the land rather thaninvest in business. He may thoughtthat it will be more profitable thanbusiness.

Figure 1: Capial to risk weighted asset ratio %

3025201510

5

SCBs

PCBs

FCBs

Chapter -5(Analytical part )

5.1Descriptive analysis

Some research regarding identification, measurement, causes and effect analysis of NPLs has been done by

scholars of our country in different times both issues within country as well as cross boarder comparison.

Nonperforming loans in the banking sector of BD, realities and challenges of NPLs in BD, Impact of

supervisions in controlling NPLs are some frequent topics of articles published in reputed journals in

our country in recent years. SCBs in our country holds major proportion of total deposit of the hole industry

but it is very unfortunate to see the regular default of loan recovery and scams by them in recent times. So to

realize the impact of this evil practice on their performance is a need of time. This paper focuses some

factors directly or indirectly affects their performance that may quest the thrust to some extent.

Source: Banking Performance Indicators, Appendix-3 (Table II), Banking regulation & Policy Department,

Bangladesh Bank, (2005-2013)

0 2007 2008 2009 2010 2011 2012 2013 2014SCBs 1.1 7.9 6.9 9 8.9 11.7 8.1 1.2

PCBs 9.8 10.6 11.4 12.1 10.1 11.5 11.4 11.4

FCBs 22.7 22.7 24 28.1 15.6 21 20.6 20.3

Figure 2: NPLs to Total Loans ratio %

30

25

20

15

10

5

SCBs

PCBs

FCBs

Non Performing Loan Rate is the most important issue for banks to survive. There are lots of factors

responsible for this ratio. Some of them belong to firm level issues and some are from macroeconomic

measures. Capital to risk weighted assets of SCBs for the selected 8 years is very much dissatisfactory. In

FY 2007 it was 1.1 % that was really alarming but gradually they started to recover it and in FY 2011 it

reached up to 8.9% which reaches up to 11.7 % in 2011 that is the highest among all the years. But in 2013

it decreases to 8.1 % and drastically fell in 2014 by touching only 1.2%. If we make a comparison the

ratio of SCBs with PCBs and FCBs then we easily have a clear idea about the competitive scenario. The

lowest value of PCBs and FCBs are

9.1 % and 15.60% respectively where the highest value of SCBs is below than 9%.

Source: Banking Performance Indicators, Appendix-3 (Table III), Banking regulation & Policy

Department, Bangladesh Bank, (2006-2014)

0 2009 2008 2009 2010 2011 2012 2013 2014SCBs 22.9 29.9 25.4 21.4 15.7 11.3 23.9 26.4

PCBs 5.5 5 4.4 3.9 3.2 2.9 4.6 6.6

FCBs 0.8 1.4 1.9 2.3 3 3 3.5 4.7

NPL is a general factor for banking as it is acceptable up to a certain limit. How much loans are being

non- performing each year is a relevant measurement in this regard. NPLs to total loans ratio for SCBs

for selected 8 years is really alarming as most of the years it holds more than 20% NPLs as per Total Loans

and Advances. In 2011 there was a breakthrough in NPL ratio in SCBs as it shows a negative growth rate

of -0.27% and the ratio was 15.70 that was a positive sign but it could not keep it up rather it touches 26.4

% in 2014 that is surely alarming. (See Figure 2) If we make a comparison among three categories of

banks we find that PCBs has maximum NPLs in 2014 and the ratio was 6.6 % and in maximum years they

are maintaining a limit within 5%.Again, FCBs are performing with a great excellence in this topic by

maintaining the limit of NPLs ratio within 3% in every selected years.

Figure 3: Comparative position of NPLs

600

500

400

300

200

100

2009 2008 2009 2010 2011 2012 2013 2014Total NPLs (in

billion)

200.1 226.2 224.8 224.8 227.1 226.4 427.3 523.1

NPLs in SCBs 115 137.9 127.6 121.6 107.6 91.7 215.1 261.55

Source: Banking Performance Indicators, Appendix-3 Banking regulation & Policy Department,

Bangladesh Bank, (2007-2014)

3025201510

50

-5-10

SCBs

PCBs

FCBs

From the above graph it has been found that SCBs hold the maximum portion of the total NPLs in banking

industry over the selected years from 2007 to 2014. Among them in 2015 the industry tested the largest

amount of NPLs that was tk. 523.1 billion dollar. There exists a consistent harmony in NPLs amount which

depicts that there is very poor initiative in controlling and recovery process of those banks. The graphical

presentation given below (figure 4) is showing the percentage of NPLs hold by SCBs of the total amount.

Here, it is found that each of the years holds more than 50% of total NPLs except in FY- 2011 and FY-

2012. So, there is a red light to the SCBs to reduce the amount of problem lending as early as possible.

Source: Banking Performance Indicators, Appendix-3 (Table IX), Banking regulation & Policy

Department, Bangladesh Bank, (2007-2014)

-15 2007 2008 2009 2010 2011 2012 2013 2014SCBs 0 0 22.5 26.2 18.4 19.7 -11.9 11.7

PCBs 15.2 16.7 16.4 21 20.9 15.7 10.2 5.5

FCBs 21.5 20.4 17.8 22.4 17 16.6 17.3 19.7

The graph can be a great source to understand how much poor the profitability trend of SCBs in our

country. In 2007 and 2008 ROE for SCBs was just 0. But this horrible situation has been changed

drastically in 2009 when the ratio touched 22.5% and the next 26.2%. In 2011 it decreased but the

percentage is tolerable. The growth rate of ROE was also so poor and in a declining mode up to 2013

also with a negative value in 2013. If we try to draw a comparative idea then find PCBs maintained at least

15% ROE in last 8 years except 2013 and 2014 with huge fall. But FCBs show a great performance as it

maintains at least 17% ROE in every year.

Based on the review of the literature it has been clear that there is extensive national as well as

international evidence which suggests that NPLs can be explained by both macroeconomic and bank

specific factors. But there are some qualitative variables that have significant effect on increasing NPLs that

can be included in a model to find out the effect. Moreover NPLs have serious negative impact on

loan growth rate. So there should have a impact of NPLs on banks profitability as it reduces loan amount

and interest income of the banks simultaneously.

5.2Multiple Regression analysis :

In order to investigate the impact, the following four research hypothesis have been developed-

H0 (1): There is no significant impact of Non Performing Loan Ratio on profitability (Net Interest

Income) of SCBs for last 8 years.

H1 (1): There is significant impact of Non Performing Loan Ratio on profitability of SCBs for last 8 years.

H0 (2): The impact of Deposit Growth Rate on SCBs profitability (NII) is statistically insignificant for last 8

years.

H1 (2): There is significant impact of Deposit Growth Rate on SCBs profitability (NII) for last 8 years.

H0 (3): The impact of Growth Rate of NPLs on SCBs profitability (NII) is statistically insignificant for last 8

years.

H1 (3): There is significant impact of Growth Rate of NPLs on SCBs profitability (NII)

H0 (4): The impact of Provision Growth Rate on SCBs profitability (NII) is statistically insignificant for

last 8 years.

H1 (4): There is significant impact of Provision Growth Rate on SCBs profitability (NII) for last 8 years.

In this paper, I have selected 4 state owned commercial banks in Bangladesh and collected data based on

some factors affect bank’s profitability as well as performance. NPL is one of the major factors of the

analysis. A model has been established to find out the significance of impact of those factors on

performance of the SCBs like the model used by Yixin Hou (2006) to find out the effect of NPLS on loan

growth rate of commercial banks. The model developed is as follows:

Y= α + β1X1 - β2 X2- β3 X3+ β4 X4+ β5 X5+ β6 X6+℮i

Where,

Y= Net Interest Income (NII)

α= Intercept Coefficient

X1= NPLs Ratio (NPLR)

X2= Deposit Growth Rate (DPGR)

X3= NPLs Growth Rate (NPLG)

X4= Provision Growth Rate of (PRVG)

β i = Slope Coefficient,

℮i =Error Term

The data used in this linear regression model is time series data as the values used here is collected

from same sources at a fixed interval of time for FY-2006 to FY-2014. Excess ratio of NPLs to total

loans is harmful for a bank as it negatively affects the lending behaviour by decreasing interest income and

loan growth rate. This paper is mainly focused on how much negative effect NPLs have on NII of SCBs

in Bangladesh.

Table : 1 Model Summaryb

Model R R Square Adjusted R Square

Std. Error of

the Estimate Durbin-Watson

1 .979a .959 .904 3.21333 2.310

a. Predictors: (Constant), PRVR, NPLR, NPLG, DPG

b. Dependent Variable: NIIR

Table-1 represent that the coefficient of correlation of the model R is 0.979that states there is strong

relationship between dependent and independent variables used in this model. Coefficient of determination

R2 0.959 that shows the highest percentage value that the independent variables explain 96 percent change

of NII. The goodness of fit test of the model is also excellent as the adjusted R2 is 0.904. The value of

Durbin Watson is 2.310 that lie within the range between 1.5 and 2.5. so we can easily state that there is

no autocorrelation among the independent variables of the study.

Table : 2 Coefficientsa

Model

Unstandardized Coefficients

Standardize

d

t Sig.

Collinearity Statistics

B Std. Error Beta Tolerance VIF

1 (Constant) 73.178 8.925 8.200 .004

NPLR -1.880 .242 -1.087 -7.777 .004 .701 1.427

DPG -.899 .295 -.481 -3.050 .055 .549 1.820

NPLG .091 .072 .195 1.257 .298 .569 1.758

PRVG -.074 .029 -.354 -2.568 .083 .719 1.391

a. Dependent Variable: NIIR

From table-2 it is found that there is a positive value of intercept coefficient (α) means that if

all the independent variables remain constant then NII will be 73.178 percent carrying a viable

economic meaning that generally there exist around 73.178 percent NII in SCBs of the

country. Slope coefficient of NPLR is -1.880 that means if NPL ratio increases by 1 percent

then the NII will be decreased by 1.88 percent and it is statistically significant at 1% percent

significant level. In case of Deposit growth rate it is found that there is inverse relationship

between NII and DPG as NII

decreases by 0.899 percent due to 1 percent increase DPG where at 5 percent significance level

it is accepted. Again, the slope coefficient of NPL growth is 0.091 that states if NPL grow

by 1 percent NII increased by 0.091 percent that is statistically insignificant at 10% significant

level. So there exists no strong negative relationship between Growth rate of NPL and NII.

Here, slope coefficient of PRVG has a value of -0.074 show a negative relationship with NII.

Due to 1 percent increase in provision growth rate NII will be decreased by 0.74%.

Table : 3 ANOVAb

Model Sum of Squares df Mean Square F Sig.

1 Regression 723.482 4 180.871 17.517 .020a

Residual 30.976 3 10.325

Total 754.459 7

a. Predictors: (Constant), PRVG, NPLR, NPLG, DPG

b. Dependent Variable: NIIR

The variables used in the regression are potentially endogenous as they are simultaneously determined

through banks’ balance sheet constraints and are correlated with each other. From the ANOVA table

(Appendix I) it is found that comparing calculated F value of 17.517 with table value at 2%

significance level the null hypothesis of H0 (1): There is no significant impact of Non-

Performing Loan Ratio on profitability (Net Interest Income) of SCBs for last 8 years, H0 (2): The

impact of Deposit Growth Rate on SCBs profitability (NII) is statistically insignificant for last 8

years, H0 (3): The impact of Growth Rate of NPLs on SCBs profitability (NII) is statistically

insignificant for last 8 years, H0 (4): The impact of Provision Growth Rate on SCBs profitability

(NII) is statistically insignificant for last 8 years are rejected. So, with 98 % confidently we can

conclude the statement that alternative hypothesis of H1 (1): There is significant impact of Non -

Performing Loan Ratio on profitability of SCBs for last 8 years. H1 (2): There is significant impact of

Deposit Growth Rate on SCBs profitability (NII) for last 8 years. H1 (3): There is significant impact

of Growth Rate of NPLs on SCBs profitability (NII)H1 (4): There is significant impact of Provision

Growth Rate on SCBs profitability (NII) for last 8 years are accepted .

Chapter- 6

Findings Recommendation Conclusion

6.1 Findings :

Finding’s 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 optimize 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. Most of the cases, it occurs when

there is an adverse selection. Averse selection is asymmetric information problem that occurs

before the transaction. For example: big risk takers or outright crooks might be the most eager to

take out a loan because they know that they are unlikely to pay it back. Because adverse

selection increases the chances that a loan might be made to a bad credit risk, lender might

decide not to make any loans, even though there are good credit risks in the market place.

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. 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.

4. There is a cyclic relation between poor economic condition and the depressed economic

growth as follows:

a. 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. Bank

try to collect loans amount as fast as possible and most of the banks have huge number of

corporate clients so they try to recover those loans as early as possible to reduce risky assets.

b. Money cycling gets stopped due to increase in NPL. Slow flowing of cash always has negative

impact on any business.

c. 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.

d. 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.

5. 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 because banks have to keep 10% of their risk weight asset as

capital or 400 cores. Banks treats loans as a risky asset. 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.

6.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.

6.2Recommendation

1. 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.

2. 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.

3. 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.

4. 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.

5. Targeting high value end NPL accounts (having exposure of Tk. 5.00 crore and above)

6. Prompt action on credit reports

7. 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.

8. A robust risk management culture, with a ‘well articulated’ risk management policy can

help the institutions to avoid such loan default.

6.3 Conclusion :

Our banking sector is characterized by low profitability and inadequate capital base because

there are lots of banks in Bangladesh. Banks revenue comes from spread (Lending rate –

borrowing rate).But there is huge competition among banks. So the profit is minimum. The crux

of the problem lies in the accumulation of high percentage of non-performing loans over a long

period of time. The problem is most severe for NCBs and DFIs. However, starting from a very

high rate of 41.1% in 1999 it came down gradually to 11.90% in 2014 according to latest

published data. Still, it is very high by any standard. Unless it can be lowered substantially we

will lose competitive edge in the wave of globalization of the banking service that is taking place

throughout the world. We have had a two-decade long experience in dealing with the NPLs

problem and much is known about the causes and remedies of the problem. 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. Therefore, this study has highlighted some challenges, shown below, for improving

the debt recovery environment and solving the NPL problems of the country as well.

Bibliography:

Books:

Basely, Scote & Brigham, F. Eugine, “Essential Managerial Finance” 13th edition, Thomson (New York).

Peter S. Rose “Commercial bank Management” fifth edition, McGraw-Hill .

Websites:

http://www.Investopedia .com

http://www.oppapers.com

http://www.ask.com

website www.bangladesh-bank.org

http://www.Financialexpress.bd.com

Articles :

Ahmed, Shahabuddin. 1998. “Ethics in Banking,” The First Nurul Matin Memorial

Lecture, May 6, Bangladesh Institute of Bank Management, Dhaka. Unpublished.

Asian Development Bank. 2003. Regional and Country Highlights - Sri Lanka.

Bangladesh Bank. 1991. Loan Classification Manual.

Bangladesh Bank. 2003. Annual Report, 2002-2003.

Bangladesh Institute of Bank Management (BIBM). 2000. Studies in Bangladesh

Banking: Series 1, BIBM, June: 67.

Banking Regulation and Policy Department, Bangladesh Bank. BCD and PRPD

Circulars, 1989-2001.

Bernanke, Ben and Lown, Cara. 1991. “The Credit Crunch.” Brookings Papers on

Economic Activity 2: 204-248.

Software:

Megastat Excel(2003), (2007); SPSS (2007) .

Appendix :

Compartive positon of NPL Table- 1 :

Urban Rural Total

NCBs 21.99 % 37.36 % 59.35 %

SBs 2.45 % 17.15 % 19.60 %

FCBs 0.56 % 0 % 0.56 %

PCBs 15.22 % 5.27 % 20.49 %

NPLs to total loan ratio Table-2 :

Year NCB SB PCB FCB Total

1997 254,540 20,110 114,230 21,240 410,120

1998 277,560 21,330 129,720 27,370 455,980

1999 307,380 25,530 135,450 31,220 499,580

2000 342,390 29,660 155,180 41,940 569,170

2001 375,790 38,170 188,730 48,240 650,930

2002 (Sept.) 400,662 44,880 222,300 60,256 728,098

Capital to risk weighted assest Table-3 :

Types of Bank Urban Rural Total

NCB 276,318 124,344 400,662

SB 24,303 20,577 44,880

PCB 202,556 19,744 222,300

FCB 60,256 - 60,256

Total 563,433 164,665 728,098

NPLs Ratio of Types of banks table-4 :

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