The persistent struggle for saving the financial system

The financial sector has been mired by the likelihood of falling into soared loans or assets in recent times. The magnitude of stressed assets has perilously risen to approximately Tk1 lakh crore (Bangladesh Development Update: World Bank). If we were to illustrate the current scenario of the sector, it would be identical to a giant edifice of Jenga blocks with several tranches but the foundation is swiftly turning into quicksand as banks and financial institutions foray into riskier territories. The task of mitigating this impending disaster might seem daunting but undertaking few prudential measures would go a long way in alleviating the inevitable.

The non-performing loans (NPL) of the country stems from a blend of primitive legislation and dearth of holistic due diligence in part of the financial institutions. The NPL are eroding the profits of the financial system and also invoking them to fall into a vicious cycle in which they are straining to assuage their losses by venturing into riskier investments and thereby sinking deeper into the abyss. The laws in place to thwart this free fall is not attuned to recovering NPL faster than the rate of newer bad loans occurring. Therefore, the NPL keeps on piling up without any quick recourse. 

The caveats in the legislative measures promulgated to stymie NPL have precipitated the financial system into dire straits. The impediments towards a more secure asset quality should be addressed by the government promptly. To begin with, the feebleness of the Negotiable Instruments Act-1881 and Money Loan Court Act-2003 for collection of funds needs to be honed for accelerated retrieval. These two legislations are used as arsenal to combat the delinquency of clients but they are deficient in a vital aspect i.e. they are not "Time Bound". The collection of funds extends to unbridled lengths due to a specific time frame not being mentioned. A matrix should be developed incorporating phases of loan recovery including specific time frames for each phase which would greatly expedite the recovery process.

Furthermore, there is a conspicuous leeway for defaulters for rescheduling of Loans. Loans are able to be rescheduled for a maximum of three times in Bangladesh. Rescheduled loans also do not have precise asset classifications which allow the borrowers to appear as non-defaulters in their CIB reports. A central database should be created for all the rescheduled loans which can be accessed by every financial institution including the collateral used to prevent the prevalence of double mortgage.

Finally, the fading prominence of the bond market behooves immediate attention. Bonds are fixed-income debt instruments which would greatly curtail the discrepancy between short term deposits and long-term assets in financial institutions due to their versatile features. The corporate bond market is worth meagerly at $0.3 billion with only two bonds listed and the Government treasury bonds stand at $17.2 billion (ADB Bond Monitor). The policies required to issue bonds should be amended to better cater to the needs of the investment appetite.  

The financial institutions should consequently strengthen facets of their framework to avert the occurrence of NPL. Firstly, the parochial concentration of funds in lieu of a broader spectrum of investment generates ailments.  It has been often seen that funds have been allocated predominantly to a specific booming industry. When a systemic shock befalls in that industry, most of the companies become susceptible to losses which cause them to default on their financing. Financial institutions should distribute funds over a large portfolio among different sectors by diversification to reduce the risk associated.

Secondly, the alarming degree of fund divergence needs to be confronted. It is a recurrent phenomenon that clients are over/under financed which causes them to divert funds. Optimum disbursement should be conducted to obviate the asymmetric nature of borrowers.

Thirdly, the consequence of poor borrower selection resonates into a decline of financial behavior. The assortment of borrowers occasionally does not meet the standards prescribed but still end up receiving funds. The KYC and early alert system of financial institutions should be enhanced for higher effectiveness of winnowing clients.

Lastly, the lack of monitoring over borrower's cash flow breeds false pretenses. The sources of funds of borrowers are sometimes neglected under the presumption of good faith. Good borrowers wind up becoming defaulters if left to their own devices. The governance of the financial institutions should be stringent and robust over borrower's cash flows to monitor them efficiently.

The issue of this predicament has come to the fore which requires vigilant and agile actions to be taken by both the government and the financial institutions for its cure. The current pandemic situation might deteriorate the situation further if both the parties do not pose a united front. Both the sides working together would be axiomatic to a sustainable development for the ensuing future.   

The writer is a Management Trainee Officer at Eastern Bank Limited