Management of NPL Loans of Commercial Banks!

Management of NPL: Meaning, Causes, Objectives and Framework

Meaning of NPA:

The bank being financial intermediaries are in the business of accepting deposits for the purpose of lending and to augment their resources at times they borrow money from other sources and meet the ever increasing borrowing requirements of their customers. However, most of the business is done by banks with the funds which are collected from the public by way of deposits. They are, therefore, answerable to the public at large, who are keeping their funds with the banks by reposing trust in the ability of banks that they will not put the depositors interest to jeopardy.

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.

Causes for growing NPA:

• Improper selection of borrowers, inadequacies of character, capacity and capital at the borrower‟s level.
• Deficiencies in appraisal, processing, sanction, and release.
• Inadequate/excess sanction of the limit irrespective of the economic size of the unit.
• Scattered financing.
• Unrealistic terms or conditions of sanction and fixing unrealistic repayment schedule.
• Political interference in sanctioning of loans and patronage to defaulters.
• Lack of infrastructural facilities like power, raw materials, fuel, transportation, marketing and technical support.
• Lack of inter-bank co-ordination as well as cooperation with financial institution in exchanging information over list of defaulters.

Objectives of NPA:

Management of NPA would have the following three specific objectives:

• Improving the quality of NPA to a performing status so that income on such assets is recognized.
• Upgrading the status of the assets so as to reduce the provisioning requirements.
• Cleansing balance-sheet of loss assets and also unsecured portion of doubtful assets.

Objectives and Importance’s of Loan Classification and Provisioning:

According to BRPD Circular No. 19 dated December 27, 2012, Bangladesh Bank has, over the last several years, positioned the banks on a path towards higher regulatory capital ratios and a more precise calculation of each individual bank‟s need for capital, through a gradual implementation of internationally recognized capital standards.

The enforcement of a stricter regulatory capital regime also requires measures to improve the accuracy of financial data which are used internally, stated in the audited financial statements and reported to Bangladesh Bank as per rules. For both the banks managerial and Bangladesh Bank‟s supervisory purposes, as well as for accurate valuation of a bank‟s capital in all of its financial reports is necessary.

An accurate valuation of capital relies, in turn, on an accurate valuation of assets. Loan loss provisioning – the recognition that some or all of the required payments on a loan may never be made – is the single most important aspect of asset valuation to bankers and bank supervisors. It is important because loans typically make up 50% or more of the total assets of the bank. Basel II and Basel III devote a great deal of attention to the distinction between “expected losses” and “unexpected losses” on the bank‟s loan portfolio. The purpose of provisioning is to take into account expected losses. Expected losses can be assigned to loans based on a loan classification system, which has been utilized in Bangladesh for many years and is being updated with this circular.

Bangladesh Bank also wishes to stress that it is the responsibility of bank management to adopt and implement proper accounting and reporting, and that correct classification and provisioning is a part of that responsibility. Loan classification and provisioning must be a key component of a regular internal loan review process that looks at the current likelihood that the borrower will repay. The value of the formed allowance that results from the provisioning process should reflect all expected losses resulting from credit exposures.

Bangladesh Bank has established requirements for general loan loss provisions, in certain percentages, for certain categories of loans that are unclassified or in the Special Mention Account. As the name suggests, general provisions are assigned to take into account the expected losses on pools of loans that are thought to have similar characteristics. The characteristics of each individual loan are not analyzed. Put differently, it is not known or even assumed which loan or loans in the pool are going to result in loan losses; it is simply taken as given that in such large pools, even those currently unclassified, there will undoubtedly be individual loans that in the future will not be repaid. Ideally, the percentages of provision that are applied to each pool are determined based on historical loss experience of similar loan pools. Banks are encouraged to calculate these historical loss experiences on the loan pools for which Bangladesh Bank has indicated general provision percentages, and use these data if they result in higher provisions than are required in this circular. Because general provisions are not formed based on expectations of loss on any individual loan, they are allowed to be included in the calculation of Tier 2 capital, subject to some restrictions. In contrast, specific provisions (established on loans that are classified as Sub-standard, Doubtful or Bad/Loss) are set up on a loan-by-loan basis after careful analysis of each individual loan‟s probability of repayment. For loans placed into any of these classification categories, weaknesses have been identified that cast doubt on the borrower‟s ability or intent to make all contractual payments in a timely manner. For this reason, specific provisions are not allowed to be included in the calculation of Tier 2 capital.

Loan classification means giving each and every loan case a status like unclassified, sub-standard, doubtful and bad or loss through verification of borrowers‟ repayment performance on a particular date while provisioning means setting aside fund from the profit (profit before provision and taxes) against possible loan loss. This is obviously essential for determining the financial health and efficiency of the banking sector. Besides, a proper loan classification and provisioning system ensures credibility of the financial system that in turn restores trust and confidence in the minds of the depositors.

Loan classification makes two pronged attacks on the activities of banks. First, interests applied on loans are not taken into account because such interests are to be taken into account only on its realization. Second, banks have to make provisions on classified loans as per guidelines by Bangladesh Bank from out of the income earned by them on performing loans.

Objectives of Loan Classification:

• Find out net-worth of a bank.
• Help for assessing financial soundness of a bank.
• Help for determining required provision and the amount of interest suspense
• Put the bank on sound footing in order to develop sound banking practice in Bangladesh.

Importance of Loan Classification:

• Strength credit discipline,
• Improve loan recovery positions and
• Make future planning of loan

Categories of Loans and Advances:

For the purpose of loan classification, loan and advances have been grouped into four categories:

• Continuous loan: The loan which is sanctioned without specific repayment schedule but there is a specific expiry date for repayment and credit limit can be treated as continuous loan. For examples: O/D, CC, PC, LIM, LTR, etc.

• Demand Loan: When loan is sanctioned on the basis of repayment depends upon the demand of bank can be treated as demand loan. Contingent or other liabilities which are converted into forced loan are also to be treated as demand loan. For examples: Forced LIM, PAD, FBP, IBP, etc.

• Term Loan: The loan which has a specific expiry date for repayment and for which repayment is schedule through specific repayment schedule is treated as fixed term loan. For example: Project finance, industrial finance, and tec.

• Short-Term Agricultural Credit and Micro-Credit: Short-Term Agricultural Credit means the credit which is enlisted as short term credit under the annual credit program announced by Agricultural Credit Department of Bangladesh bank. Credit in agriculture sector repayable within 12 months is also included in this category. On the other hand, Short-Term Micro-Credit means the credit which have loan limit less than TK. 25000.00 and repayable within 12 months. Micro-credit may be even non-farm credit, self-employment credit, loom-loan or any forms of credit under the own credit program of the banks.

Basis for Loan Classification:

If any uncertainty or doubt arises in respect of recovery of any Continuous Loan, Demand Loan or Fixed Term Loan, the same will have to be classified on the basis of qualitative judgement be it classifiable or not on the basis of objective criteria. If any situational changes occur in the stipulations in terms of which the loan was extended or if the capital of the

Borrower is impaired due to adverse conditions or if the value of the collateral decreases or if the recovery of the loan becomes uncertain due to any other unfavourable situation, the loan will have to be classified on the basis of qualitative judgement .

Despite the probability of any loan being affected due to the reasons stated above or for any other reasons, if there is any hope for change of the existing condition by resorting to proper steps, the loan, on the basis of qualitative judgement, will be classified as ‘Sub-standard ‘. But even after resorting to proper steps, there exists no certainty of total recovery of the loan, it will be classified as ‘ Doubtful ‘ and even after exerting the all-out efforts, there exists no chance of recovery, it will be classified as ‘ Bad/Loss ‘ on the basis of qualitative judgment.

For incorporating qualitative judgment, banks must focus on the likelihood that the borrower will repay all amounts due in a timely manner, using their own judgment and the following assessment factors:

(1) Special Mention:

1. Assets must be classified no higher than Special Mention if any of the following deficiencies of bank management is present: the loan was not made in compliance with the bank‟s internal policies; failure to maintain adequate and enforceable documentation; or poor control over collateral.

1. Assets must be classified no higher than Special Mention if any of the following deficiencies of the obligor is present: occasional overdrawn within the past year, below-average or declining profitability; barely acceptable liquidity; problems in strategic planning.

(2) Sub-standard:

1. Assets must be classified no higher than Sub-standard if any of the following deficiencies of the obligor is present: recurrent overdrawn, low account turnover, competitive difficulties, location in a volatile industry with an acute drop in demand; very low profitability that is also declining; inadequate liquidity; cash flow less than repayment of principal and interest; weak management; doubts about integrity of management; conflict in corporate governance; unjustifiable lack of external audit; pending litigation of a significant nature.

1. Assets must be classified no higher than Sub-standard if the primary sources of repayment are insufficient to service the debt and the bank must look to secondary sources of repayment, including collateral.

1. Assets must be classified no higher than Sub-standard if the banking organization has acquired the asset without the types of adequate documentation of the obligor‟s net worth, profitability, liquidity, and cash flow that are required in the banking organization‟s lending policy, or there are doubts about the validity of that documentation.

(3) Doubtful:

Assets must be classified no higher than Doubtful if any of the following deficiencies of the obligor is present: permanent overdrawn; location in an industry with poor aggregate earnings or loss of markets; serious competitive problems; failure of key products; operational losses; illiquidity, including the necessity to sell assets to meet operating expenses; cash flow less than required interest payments; very poor management; non-cooperative or hostile management; serious doubts of the integrity of management; doubts about true ownership; complete absence of faith in financial statements.

(4) Bad/Loss

Assets must be classified no higher than Bad/Loss if any of the following deficiencies of the obligor are present: the obligor seeks new loans to finance operational losses; location in an industry that is disappearing; location in the bottom quartile of its industry in terms of profitability; technological obsolescence; very high losses; asset sales at a loss to meet operational expenses; cash flow less than production costs; no repayment source except liquidation; presence of money laundering, fraud, embezzlement, or other criminal activity; no further support by owners.

Current Loan Classification and Provisioning System as per Latest BRPD Circular in Bangladesh:

Since 1989, Bangladesh follows both “overdue criteria” and “qualitative criteria” to deem a loan classified or unclassified. According to overdue criteria, as suggested by Bangladesh Bank, bank managers usually divide all loans into five categories (continuous loan, demand loan, term loan payable within five years, term loan payable in more than five years and short-term agricultural credit / micro credit), and then observe periods elapsed for repayments. All troubled loans are then further reclassified as special mention account (SMA)⁷, substandard, doubtful and bad/losses to comply with international norms of loan classification. Further, in order to keep the management up to date about the status of loans, bank managers review the loan quality on a quarterly basis. With some exceptions, the banking sector at present follows a norm of six months overdue for deeming a loan nonperforming. The current loan classification and provisioning system (in a summary form) in use in Bangladesh is shown below in table 2.

Table 1: Current loan classification and provisioning system as per latest BRPD in Bangladesh

Maintenance of Provision:

1. General Provision: Banks will be required to maintain General Provision in the following way:

• @ 0.25% against all unclassified loans of Small and Medium Enterprise (SME) as defined by the SME & Special Programmes Department of Bangladesh Bank from time to time and @ 1% against all unclassified loans (other than loans under Consumer Financing, Loans to Brokerage House, Merchant Banks, Stock dealers etc., Special Mention Account as well as SME Financing.)
• @ 5% on the unclassified amount for Consumer financing whereas it has to be maintained @ 2% on the unclassified amount for (i) Housing Finance and (ii) Loans for Professionals to set up business under Consumer Financing Scheme.
• @ 2% on the unclassified amount for Loans to Brokerage House, Merchant Banks, Stock dealers, etc.
• @ 5% on the outstanding amount of loans kept in the ‘Special Mention Account’.
• @1% on the off-balance sheet exposures. (Provision will be on the total exposure and amount of cash margin or value of eligible collateral will not be deducted while computing Off-balance sheet exposure.)

1. Specific Provision: Banks will maintain provision at the following rates in respect of classified Continuous, Demand and Fixed Term Loans:

(1) Sub-standard: 20%

(2) Doubtful: 50%

(3) Bad/Loss: 100%

1. Provision for Short-term Agricultural and Micro-Credits:

• All credits except ‘Bad/Loss’ (i.e. ‘Doubtful’, ‘Sub-standard’, irregular and regular credit accounts): 5%
• ‘Bad/Loss‟ : 100%

To Sum up:

The base for provisions on non-performing loans was the balance outstanding in the loan ledger for the loan, less any interest taken in an interest suspense account. However, the base for provision shall be further reviewed towards closer convergence with international best practice standards.

In latest BRPD circular no. 19 dated December 27, 2012, an amended and revised loan classification and provisioning procedure was introduced by the Bangladesh Bank to bring it in line with the international standards. This was implemented in five phases, the last of which ended in December 2012. In the revised policy, the duration for loans to be classified under various categories was drastically reduced, while the frequency of classifications was increased. For classification and provisioning under the revised procedure banks were instructed to classify the loans in following procedure:

Rate Provision: Table-2

Source: BRPD circular no. 07 / 2012

Base for Provisioning and Accounting Treatment of NPLs:

Base for Provision:

For eligible collaterals of the following types, provision will be maintained at the stated rates on the outstanding balance of the classified loans less the amount of Interest Suspense and the value of eligible collateral:

1. Deposit with the same bank under lien against the loan, b. Government bond/savings certificate under lien,
2. Guarantee given by Government or Bangladesh Bank.

For all other eligible collaterals, the provision will be maintained at the stated rates on the balance calculated as the greater of the following two amounts:

1. outstanding balance of the classified loan less the amount of Interest Suspense and the value of eligible collateral; and
2. 15% of the outstanding balance of the loan.

Accounting of the Interest of Classified Loans:

If any loan or advance is classified as ‘Sub-standard’ and ‘Doubtful’, interest accrued on such loan will be credited to Interest Suspense Account, instead of crediting the same to Income Account. In case of rescheduled loans the unrealized interest, if any, will be credited to Interest Suspense Account, instead of crediting the same to Income Account.

As soon as any loan or advance is classified as ‘Bad/Loss’, charging of interest in the same account will cease. In case of filing a law-suit for recovery of such loan, interest for the period till filing of the suit can be charged in the loan account in order to file the same for the amount of principal plus interest. But interest thus charged in the loan account has to be preserved in the ‘Interest Suspense’ account. If any interest is charged on any ‘Bad/Loss’ account for any other special reason, the same will be preserved in the ‘Interest Suspense’ account. If classified loan or part of it is recovered i.e., real deposit is effected in the loan account, first the interest charged and accrued but not charged is to be recovered from the said deposit and the principal to be adjusted afterwards.

“Making provision stemmed from the credit transactions such as credit sales. Sales on any basis other than for cash make possible the subsequent failure to collect the account. An uncollectable account receivable is a loss of revenue that requires, through proper entry in the accounts, a decrease in the asset accounts receivable and related decrease in income and stockholders‟ equity. Recording the bad debt expense recognizes the loss in revenue and the decrease in income. Of the two methods of recording uncollectible accounts receivable, the allowances method is appropriate in situation where it is probable that an asset has been impaired and that the amount of the loss can be reasonably estimated since the collectability of receivables is considered a loss contingency. A receivable is a prospective cash inflow, and the probability of its collection must be considered in valuing this inflow (Kieso et al, 2001).”

On the other hand, an uncollectable loan/advance for the banking business is not only a loss of revenue, but also a loss of capital. The uncollectible interest receivable is the loss of revenue and the uncollectable principal is the loss of capital. An analogy between the uncollectable account receivable and the uncollectable interest can be drawn as:

Sales price= Cost+ Mark up fir risk premium and profit expectation (spread)

So, the provision against the interest receivable can be treated as a normal business expense since it reflects the probable loss of revenue.

The conflict may arise that the nature of banking business is different from the nature of other business and banks are not utilizing the capital directly to generate revenue-generating goods whereas other business do. But the banks take the collateral against the loans and advances mainly to create pressure for timely repayment of loans and advances. From this it is evident that the loss of a capital is the fault of either of the legal system or of the political system of management system but neither of the shareholders nor the depositors. Under protectionist banking systems like Bangladesh there is less chance that the depositors will be deprived in case of a bank failure. So, the loss is of the owners (shareholders).

Now a day the bank managers of Bangladesh deduct the amount of interest suspended and the value of “eligible securities”⁵ 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 9%). With regard to income recognition, as the banking sector follows IAS 30⁶ for preparing financial statements, 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.

Framework of NPA:

Risk is inherent in all aspects of a commercial operation; however for banks and financial institutions, credit risk is an essential factor that needs to be managed. Credit risk is the possibility that a borrower or counter party will fail to meet its obligations in accordance with agreed terms. Credit risk management needs to be a robust process that enables banks to proactively manage loan portfolios in order to minimize losses and earn an acceptable level of return for shareholders. And NPL management must be thought of as an integral part of overall credit risk management. It implies that NPL management is not an independent event, that stats with conversion of a performing loan into non-performing loan. In fact a robust NPL management must start before a loan becomes non-performing. It is much better to prevent an NPL, rather than curing or nursing an NPL.

Figure 1: NPL Management Strategy

NPL Management Strategy, in figure 2, explains that the incidence of non-performing advances (NPAs) is affecting the performance of the credit institutions both financially and psychologically. The successful banker-client relationship in the credit function of banks involves three important and interlinked phases viz.:

• The right type and the right amount of credit are given to the right type of client.
• The borrower‟s makes proper use of the amount received from the bank.
• The borrower repays the outstanding loan along with the interest in time. Management of NPAs shall rely upon the following basic principles:
• Recovery of normal loans and advances
• Recovery of NPAs
• cells needs to be set up to monitor recovery and prevent fresh generation of NPA.
• Adequate attention should be given and appropriate action initiated for upgrading substandard assets to Compromise should be a negotiated settlement under which banks should ensure recovery of maximum dues with minimum expenses.
• Proper distinction needs to be made between willful defaulters and borrowers who defaulted due to circumstances beyond their control.
• In settlement cases the banks should promptly recycle the fund with advantage instead of resorting to expensive recovery proceedings spread over a long period.

When the bank is entering into compromise settlement the following points need to be remembered:

• Maximum recovery with minimum cost.
• Distinction needs to be made between willful defaulters and defaulters on account of conditions beyond their scope.
• Where security is available, proper weightage needs to be given location, marketability conditions, possession thereof.
• Fund recycling to maximum advantage instead of opting for lengthy, expensive recovery process.
• All compromise proposals should be reported to the next higher authority for scrutiny so as to prevent fraudulent activities.
• Before presenting the compromise proposal before the Settlement Advisory committee, the proposal needs to be examined by the top executive.
• Special recovery standard assets.

As a Preventive measure there should have proper screening before disbursement of the Loans and surveillance such as:

• To select right borrowers.
• To identify viability of project.
• To ascertain credit environment.
• To assess credit need.
• To timely supply of credit.
• To obtain proper securities.
• To prevent defective documentation.
• To maintain credit discipline.

Recovery of credit largely depends on effective follow-up. By supervision we mean to have a proper control over the borrowers operation to ensure the end-use of funds. Supervision keeps track of the end-use of fund lent. Supervision and follow-up function in banks has assumed considerable significance due to increasing trend of sickness in industrial units.

Loan Review:

Loan review is not luxury but necessary for a sound bank lending program. The structure of credit review process would have to periodically examine the assumptions on which every loan was appraised and granted, and whether these assumptions have changed materially enough to endanger the debt-servicing capacity of the borrower. Typically, all or most of the following aspects are reviewed for every loan till it is repaid in full.

• Developments in the economy that may have an impact on the industry in which the borrower operates.
• Developments in the industry or sector in which the borrower operates.
• The borrowers’ payment record in this and other loans so far.
• The quality, condition and value of the prime and collateral securities.
• The completeness of loan documentation, and developments in law governing the instruments effecting credit delivery.
• Some borrowers may default on debt service due to factors out of their control. In such cases, the bank may have to reschedule the debt requirements and alter some of the covenants, if necessary.

Central banks of most countries have devised country-specific definitions and control systems to tackle „sick‟ borrowers. There are three categories of sickness that could afflict borrowers:

1. Sickness at birth- the project itself has become infeasible either due to faculty assumptions or a change in environment.
2. Induced sickness- caused by management in competencies or willful default.
3. Genuine sickness-where the circumstances leading to sickness are beyond the borrower‟s control, and has happened in spite of the borrowers sincere efforts to avert the situation.

Key Steps for Loan Workout:

• Always keep the goal of loan workouts firmly in mind: to maximize the banks chances for full recovery of its funds.
• The repaid detection and reporting of any problems with a loan are essential; delay often worsens a problem loan situation.
• Keep the loan workouts responsibility separate from the lending function to avoid possible conflicts of interest for the loan offer.
• Bank workout specialists should confer with the troubled customer quickly on possible options, especially for cutting expenses, increasing cash flow, and improving management control.
• Develop a preliminary plan of action after determining the banks risk exposure and sufficiency of loan documents especially any claims against the customer‟s collateral other than that held by the bank.
• Estimate what resources are available to collect the trouble loan including the estimated liquidation values of assets and deposits.

Loan review helps in the following:

• Continuously checking if the loan policy is being adhered to.
• Identifying problem accounts even at the incipient stage.
• Assessing the bank‟s exposure to credit risk.

Bangladesh Bank’s Guidelines as per Latest BRPD Circular for Loan Classification

In order to get rid of default loans and to protect the bank capital from this engulfing crisis the government also formed a committee in 1986 in the name of National Commission on Money, Banking and Credit for providing suggestions on non-performing loans so as to improve the efficiency of the banking system. The Word Bank also, at this time started making an in-depth study on the financial sector of Bangladesh.

Regarding the default loans, Bangladesh Bank, however, asked the commercial banks to use their own subjective criteria for the identification of problem loans and to maintain provisions against it. Therefore, it appears that the banking sector as a whole simply neglected the identification of problem assets as well as maintenance of proper provision on it.

At that time banking community used to believe that they would be able to realize the time bared loans in full after selling the security kept against it. And as such, they used to deem accrued interest on the non-performing loans as their income following the accrual principles of accounting. Hence, both the profit and loss account and the balance sheet did not reflect thee actual position and both dividend and taxes were paid from the overstated income. This practice seriously eroded the capital bases of the banks till the end of 1989, as before that there were hardly any policy guidelines by the central bank regarding classification of loans and maintenance of provisions against it. Of course, there was also an absence of appropriate laws relating to recovery of default loans.

In order to curb continuing financial distress and to arrest increasing growth of default loans, Bangladesh Bank formally introduced BCD Circular No-34 on November 16, 1989 on loan classification and making provisions thereof. The circular states that henceforth the banks themselves will carry out the classifications of their loans at least once in a year on the basis of the position existing on December 31 (annual closing date) in accordance with the guidelines given in the BRPD Circular No. 07 on June 14, 2012: Loan Classification and Provisioning. It also states that except for agricultural short-term loans, all loans are to be classified as either classified’ or unclassified‟. Classified loans are to be considered as those loans that have a reduced chance of repayment and are to be further classified as substandard, doubtful and bad/ losses. It further states that the bank will use both overdue and qualitative judgment criteria to deem a loan classified or unclassified.

Loan Rescheduling:

Latest BRPD circular no. 19 dated December 27, 2012, Bangladesh Bank recognizes that in some cases, a legitimate banking practice may allow for the renewal of a continuous loan or line of credit. Occasionally, even a term loan is renewed or extended under unfortunate circumstances that are beyond the control of the borrower and do not signify that the borrower’s willingness or ability to repay has deteriorated the loan. However, Bangladesh Bank is concerned that rescheduling (also known as “prolongation” or “evergreening”) may sometimes result in an overstatement of capital, when loans that have a low probability of repayment are carried at full value on banks’ balance sheets. Bangladesh Bank is hereby issuing this circular in order to communicate its policy stance that rescheduling should be done only in limited circumstances and under restrictions.

Time Limit for Rescheduling:

Banks shall comply with the following instructions while considering application for loan rescheduling of non-performing loan (loans classified as Sub-standard, Doubtful and Bad/Loss) and the rescheduling shall be for a minimum reasonable period of time. Time limit for rescheduling of different categories of loans will be as follows:

a) Time limit for rescheduling Continuous Loan:

The loan account in which transactions may be made within certain limit and have an expiry date for full adjustment will be treated as Continuous Loan:

Conditions: During the rescheduled period all required principal and interest payments must be made. Rescheduled amount should be repaid in monthly installments. If the amount of defaulted installments is equal to the amount of 3(monthly) installments, the loan will be classified as Bad/Loss.

b) Time limit for rescheduling Demand Loan:

The loan which becomes repayable on demand by the bank is treated as Demand Loan. If any contingent or any other liabilities are turned to forced loan (i.e. without any prior approval as regular loan) those too will be treated as Demand Loans.

Conditions: During the rescheduled period all required principal and interest payments must be made. Rescheduled amount should be repaid in monthly installments. If the amount of defaulted installments is equal to the amount of 3(monthly) installments, the loan will be classified as Bad/Loss.

c) Time limit for rescheduling Fixed Term Loan:

The loan which is repayable within a specified time period under a prescribed repayment schedule is treated as Term Loan.

Conditions: During the rescheduled period all required principal and interest payments must be made. Rescheduled amount should be repaid in monthly/quarterly installments. If the amount of defaulted installments is equal to the amount of 6 monthly or 2 quarterly installments, the loan will be classified as Bad/Loss.

d) Time limit for rescheduling for Short-term Agricultural and Micro-Credit

1. If the loan becomes default after third rescheduling, the borrower will be treated as a habitual loan defaulter and the bank shall not consider for further loan rescheduling.
2. Approval of loan rescheduling cannot be made below the level at which it was originally sanctioned. A detailed appraisal report including implications of such loan rescheduling on the income and other areas of the bank must be placed to the approving authority at the time of placing the rescheduling proposal.

Bangladesh Bank through its BRPD circulars issued at different times, have announced various Policy for Rescheduling of loans, to commercial banks at warning about non-performing loan. The purpose of this Policy for Rescheduling of loans is to encourage commercial banks to accelerate growth by providing loans to these priority sectors. Policy guidelines and instructions have also been circulated to Commercial Banks for their adoption. Instructions of, 2006 BRPD Circular No. 02 dated February 14 hereby stand superseded by this circular.

The issue has been reviewed and it has been decided that the borrowers whose credit facility has been rescheduled will get new loan facility subject to fulfilment of the following conditions:-

1. The defaulting borrower who has availed interest waiver must settle at least 15% of the compromise amount (excluding the down payment on rescheduling as per present guidelines) to avail any further credit facility from any Bank.
2. In case of borrowing from other Banks, the same rule will be applicable, i.e. the borrower will have to settle at least 15% of compromise amount (excluding the down payment on rescheduling as per present guidelines), then, will be allowed to take regular facility from other Banks subject to the submission of NOC (No Objection Certificate) from the rescheduling bank.
3. If there is any Principal waiver, no fresh facility will be allowed till the full settlement of compromise amount.
4. Export borrowers may be granted further credit facility (after being identified as not a willful defaulter), if required, subject to settle at least 7.5% of the compromise amount (excluding the down payment on rescheduling as per present guidelines) being paid.
5. Prior approval of Bangladesh Bank shall have to be obtained if the loan is related to the director/ ex-directors of a Bank Company.
6. If any such issue is already there (such fresh facility has already been allowed after allowing waiver), the same will not fall under purview of this circular.
7. Information on the loan accounts rescheduled shall be reported to the Credit Information Bureau (CIB) of Bangladesh Bank. While reporting to the CIB, such rescheduled loans/advances may be shown as RS 1 for first rescheduling, RS 2 for second and so on. Interest waivers given to the entity should be mentioned as RSIW & Principal waivers granted should be designated as RSPW.

According to the qualitative judgment criteria, bank managers classify any loan if it forecasts the uncertainty of recovery of the loan due to the following reasons:

• Credit extended without approval of competent authority or without any logical basis (under pressure).
• Incomplete documentation.
• Insufficient security or drastic fall in the value of security.
• Borrower sustains heavy loss in capital due to natural calamity or business condition.
• Frequent overdraw of limit
• Rescheduling terms are not maintained.
• Borrower cannot be traced or death of the borrower.
• Filing a suit against the borrower for recovery of credit.

6. Causes of Loan Default Problem
7. Entrepreneurs Related:

A1: 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.

A2: 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.

A3: 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.

A4: 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.

A5: 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.

B: Business Related:

B1: 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.

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 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.

B4: 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.

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 in 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. But 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.

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 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.

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.

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 the political turmoil is considered one of other causes of the loan default in our country.

D4: 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.

Indicators and Remedies of Loan Default Problem:

Before analyzing the remedies of loan default problems we will discuss the indicators of default loan which would indicate financial trouble and serve as a “red flag” to the financial officer. There are many indicators of default loans but there is no set pattern of frequency of occurrences of events leading up to a point where a loan could be declared a problem loan.

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.
  • Step to be taken for Nonperforming Loan management NPL

1.  Remainders.
2. Visit of customer or business enterprise.
3. Legal Notice.
4. Restructuring the loan with new terms or collateral; or restructuring the business with new lending or equity.
5. Exercising the right of Lien.
6. Cash settlement via the sale of underlying collateral as per Artha Rin Adalat Ain-2003.
7. Cash settlement via the sale of other assets or other cash sources of the borrower.
8. Repossession of the real estate or assets..
9.  Out of court restructurings.
10. Recovery through Court:

(i).   NII. Act.

(ii)   Artho Rin Adalat Ain.