Banking sector threatened by ever-greening of bad loans

Many banks and financial institutions (BFIs) in the country are supporting cash-strapped borrowers by extending them additional credit line to enable them to repay the old debt, encouraging ever-greening of bad loans in the banking sector, the latest World Bank report says.

This indicates that the level of bad debt in the banking sector may be higher than that reported by Nepal Rastra Bank (NRB).

It is said the level of bad debt, or non-performing loan, currently stands at a modest 3.8 per cent of the total loans extended by BFIs. Yet much is still unknown about the true health of the financial sector, as ever-greening is believed to be widespread, says the World Bank’s Nepal Economic Update 2014.

“Although we do not have data on the proportion of such loans, recurrent anecdotal evidence suggests that ever-greening is widespread,” said WB’s Senior Country Economist Aurlien Kruse.

Ever-greening refers to practices whereby banks extend new loans to customers to allow them to remain current on obligations from previous bad loans, explains the WB report, adding, “It is quite common, and appropriate, for banks to revisit the original terms of a loan when solvent corporate clients are faced with temporary liquidity shortage.”

But what is startling in Nepal, according to the WB, is that this practice has been largely indiscriminate and unrelated to an assessment of borrowers’ ultimate repayment capacity.

One of the reasons why BFIs resort to this malpractice is to ‘avoid provisioning changes’. Currently, BFIs have to separate one per cent of the total loan for loan loss provisioning even if no defaults are made in payments. But this amount can go up to 100 per cent of the credit in case borrowers fail to pay instalments for a year.

Since this rule compels BFIs to lock up quite a significant amount in case of defaults, they apply cosmetic measures to turn ‘bad loans’ into ‘good loans’.

Also, the NRB provision that bars BFIs from making dividend payments if they hold non-performing loans of over five per cent may have prompted bank managers to underreport bad loans, driving a wedge between NRB’s assessment of the health of BFIs and the institutions’ own understanding of their risk, notes the report.

Therefore, in the short-term, NRB should carry out an in-depth review of weaknesses of BFIs and build its capacity to provide effective supervision, says the report. “Over time, banks and NRB should move increasingly towards carrying out asset quality reviews so that the assessment of overall portfolio health and decisions on new loans could be made on the basis of detailed analysis of the borrowers’ repayment capacity rather than history.”

source: the himalayan times,22 april 2014
LINK

Comments