Industrial sickness and default loans: A threat to economic growth in Bangladesh

Illustration: TBS

The borrower is expected to pay the dues on time as agreed in the loan agreement but sometimes they may pay the agreed instalments agreed due to various reasons. The borrowers may be categorised as defaulters and non-defaulters. 

The reasons for default should be evaluated in order to give appropriate treatment to the defaulters.

Industrial sickness

When an industrial enterprise becomes irregular in repayment of scheduled instalments of loans to financial institutions (FIs) is called sick industry and becomes a loan defaulter after failing to repay, as classified by Bangladesh Bank. 

The concept of industrial sickness has been embodied under section 2 (46 AA) of the Indian Companies Act, 1956, Section 3(1) (O) of Sick industrial companies (special provision amendment) Act, 1993, but no law in Bangladesh has defined Industrial sickness.

Industrial sickness does not occur overnight. There are few stages of the process of sickness: initial or normal stage, tending towards sickness stage, incipient sickness stage and final stage (Navulla & Sunitha, 2016).

The signs of industry weakness include frequent breakdowns of equipment before their expected lifespan, reduced efficiency, low use of production capacity, and falling production levels.

Other visible issues are a high turnover of workers, failure to meet financial agreements, poor record-keeping, irregular payments to creditors, suppliers, and employees, and operating below the breakeven point. These problems often lead to business losses, cash shortages, and a decline in assets.

It takes from 5 to 7 years to corrode the health of a unit beyond cure and make the unit sick. Any of these symptoms indicate probable sickness and can enable the prediction of potential business failure or sickness at the earliest.

The present study will identify which measures are appropriate to prevent sickness and default loans in the present context of Bangladesh.

Industrial sickness is rising due to increasing competition and changes in economic, political, social, cultural, legal, and global environments. This weakens borrowers financially, wastes limited resources (Navulla et al., 2016), and eventually leads to industries defaulting, causing non-performing loans (NPLs) for lenders.

Non-performing loan (NPL)

A non-performing loan (NPL) is the sum of borrowed money upon which the debtor has not made his/her scheduled payments within the stipulated time. On the other hand, NPL is a non-performing asset (NPA) for FIs since the borrower has not paid any previously agreed upon interest or principal to the lender for a specified period of time.

In effect, both NPL and NPA have the same meaning and they are used synonymously in different literature.

The problem of NPAs is not only for bankers but indeed for policy makers of the country. It is such a systematic risk factor that has a strong impact on all the FIs. NPAs are the sources of systematic risks that are beyond the FI's control (Ouhibi et al., 2017).

The growth of NPAs is a serious problem for the banking industry. NPAs are "financial pollution" and may be harmful to economic growth. 

There are some other empirical evidence that show integrity of the borrower as a major cause of non-performing loans. One empirical study conducted on microfinance institutions in Kenya also indicates lack of technical training for loan beneficiaries and the performance of entrepreneur businesses as a critical driver of loan delinquency occurrence.

Many factors contribute to non-performing loans (NPLs) globally. Negera (2012), in a study on Ethiopia, identified key causes such as poor credit evaluation, weak loan monitoring, lack of a strong credit culture, lenient loan terms, risky lending practices, dishonest borrowers, weak institutions, unfair bank competition, misuse of funds, borrowers' lack of knowledge, and improper loan amounts.

The study found that poor credit assessment, caused by limited skills of credit officers, weak institutional capacity, and lack of national data for project financing, led to unrealistic loan terms that were not properly discussed with borrowers, resulting in loan defaults.

Joseph et al. (2012) conducted a study to determine the causes of NPLs in Zimbabwe. They found that internal factors such as poor credit policy, weak credit analysis, poor credit monitoring, inadequate risk management and insider loans have limited influence towards NPLs. Factors namely natural disaster, government policy and the integrity of the borrower were the major factors.

Various studies show that loan defaults are influenced by three main factors: bank-specific, borrower-specific, and external or macroeconomic factors.

A 1990 study titled "Problem of Repayment to Development Finance Institutions (DFIs) in Bangladesh" analysed loan defaults in selected enterprises. Key reasons included delays in financing, cost increases during project implementation, wrong or disputed machinery selection, conflicts between bankers and borrowers, low project capacity utilisation, poor management, and issues with infrastructure, marketing, and working capital.

A 1991 study on DFIs analysed 120 borrowers and found that loan defaults were linked to issues in project implementation and operations. Another study on 125 major loan defaulters identified political ties, utility disruptions, close relations with bankers, corruption, willful non-payment, and fund misuse as key causes.

Defaulters are divided into willful and non-willful. Some of the studies indicated in the foregoing, suggested undertaking further studies for careful discrimination between wilful defaulters and non-willful defaulters.

Wilful versus non-wilful defaulters

There are few studies on the discrimination of willful and non-willful defaulters in different sectors of business. 

A study was conducted through dialogue and interview of 96 available and agreed SME classified loaners from at least one district of the northeast, northwest, southeast and southwest regions of Bangladesh (namely Sylhet, Rangpur, Chittagong and Khulna divisions) (Shah, 2014).

Interviews were carried out between June and September 2013 at the urban and rural levels, where all of them have classified loans and some of them are defaulters. Only four of them mentioned that they had suffered business losses due to natural calamities, 72 of them mentioned that they had utilised the funds only for the original purpose of the loan, while the remaining 24 mentioned that they had used a part or all of the funds for purposes other than the original one without informing the bank.

Out of those 24 respondents, five used the loan for their business, five for starting a transport business, and four invested in the stock market (losing money in the 2010 crash). Three bought land, three used the funds for medical treatment, and the remaining three used the money for a daughter's wedding, gave it to others, or paid off other debts. While 25% admitted to misusing the loan, it's likely that a higher percentage did so without admitting it.

Laws and regulations to recover default loan

Most of the countries have laws for recovery of default loans including Bangladesh, India, Pakistan, Nepal etc. There are different treatments in loan recovery laws for willful and non-willful defaulters.

Bangladeshi law of loan recovery has no such differentiations of willful and non-willful defaulters.

Unlike Bangladesh, other countries have legal provisions to identify the willful defaulters. Bangladesh's Finance Companies Act 2023 section 2 (5) and 30 defined the willful defaulters as under: 

Any borrower will become a willful defaulter if:

Obtain loan, investment of any other financial benefits, interest or profits not paid back despite the ability to pay; obtain loan, investment or other financial benefits in favour of himself, any family member, or any other person with whom he has self-interest or in the name of the company under fraud, misinformation and do not pay back; any loan or financial benefits used otherwise than the actual purpose of the loan; the mortgages and security given against a loan transfer or change of hand without written permission of the financial company.

Bangladesh Bank (BB) has directed non-bank financial institutions (NBFIs) to set up willful defaulter identification units to avoid stricter measures by the central bank.

The BB circular instructed NBFIs to set up the identification units led by officials two levels below the managing director and chief executive officer (CEO) of the finance company. The management must carry out all related activities throughout the unit.

The unit will be responsible for identifying whether defaulting borrowers (individuals and institutions) qualify as willful defaulters, according to the central bank notice.

The identification process must begin within 30 days of a borrower defaulting. This timeframe can be extended by a further 30 days with justification.

If a borrower is classified as a willful defaulter according to the Finance Companies Act 2023, they will be granted 14 working days to respond to the accusation, says the circular.

Non-compliance with regulations regarding willful defaulters will result in fines for NBFIs ranging from Tk5 million to Tk10 million. Continued violations will incur a daily penalty of Tk100,000 by the central bank, it mentions.

Banking laws in Bangladesh do not distinguish between innocent borrowers and willful defaulters, treating them the same. This discourages investment and entrepreneurship. The law for non-willful defaulters should be less severe than for willful defaulters.

M S Siddiqui. Sketch: TBS

M S Siddiqui is a former non-government adviser, Bangladesh Competition Commission, Legal Economist, and CEO of Bangla Chemical. 

Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinions and views of The Business Standard.