Non-Performing Loan in Bangladesh Banking Industry

Topics: Bank, Economics, Debt Pages: 5 (1351 words) Published: October 1, 2011
Nonperforming loans (“NPLs”) refer to those financial assets from which banks no longer receive interest and/or installment payments as scheduled. They are known as non-performing because the loan ceases to “perform” or generate income for the bank. NPLs are viewed as a typical byproduct of financial crisis: they are not a main product of the lending function but rather an accidental occurrence of the lending process, one that has enormous potential to deepen the severity and duration of financial crisis and to complicate macro economic management. This is because NPLs can bring down investors’ confidence in the banking system, piling up unproductive economic resources even though depreciations are taken care of, and impeding the resource allocation process.

In a bank-centered financial system, NPLs can further thwart economic recovery by shrinking operating margin and eroding the capital base of the banks to advance new loans. This is sometimes referred to as “credit crunch”. In addition, NPLs, 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 economic and financial implications of NPLs in a bank-centered financial economy can be best explained by the following diagram:

Loan (NPL)

Loss of

loan loss

of banks


Low economic

Low rate of investment

High loan

High risk

Figure: Economic and financial implications of NPLs

The above figure illustrates the catastrophic effect of NPLs in a bank-centered financial system. Having such a system, Bangladesh needs to study the condition of NPLs on a routine basis in order to augment investible capital in the productive sectors as well as to ensure sustainable economic growth.

Smooth and efficient flow of saving-investment process is a prerequisite for the economic 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). The latest data reveal that 8.47% % of total loans are classified in our banking sector.

Although, the ratio was as high as 41.1% in 1999 and it came down gradually to the present level of 8.47 %, still it is higher than the tolerable range and, thus, is a threat to our banking sector. It is very vivid that NPLs reduce banks’ profitability, as banks cannot appropriate interest income from their classified loans. NPLs reduce loanable 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.

Source: Bangladesh Bank Annual Report

The table above shows the non-performing loans ratio from the year 1997 to 2010 (September). The peak was in 1999 with a rate as high as 41.1%. A devastating country-wide flood in 1998 was responsible for the surge in loan classification rate in 1998 and in1999. Then, we see an encouraging declining trend of the rate and latest data reveals that 8.47% of total loan is adversely classified. As now the commercial banks strengthened their loan recovery mechanism and write-off measures introduced in the banking sector which resulted the strengthened loan recovery mechanism.

Source: Bangladesh Bank Annual Report

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