Stricter NPL Rules Could Backfire

Introduction

Bangladesh’s banking sector faces a pivotal decision: Should it tighten non-performing loan (NPL) regulations now or take a more strategic approach to safeguard its fragile economy?

New Regulations and Potential Impact

Recent reports indicate that Bangladesh Bank is preparing to implement stricter policies for classifying loans as non-performing by March next year. Under the proposed policy, loans delayed by more than three months past their due date would be classified as NPLs, reducing the current grace period of six months by half. While the move may appear to address the escalating NPL crisis, experts warn that such measures could have the opposite effect, causing NPLs to balloon from the already alarming figure of Tk284,977 crore to over Tk500,000 crore.

The Root of the Problem

NPLs have long been a thorn in the side of Bangladesh’s banking sector, currently accounting for 17% of total loans—a stark indicator of the system’s inefficiencies. However, the issue is not isolated. Non-performing loans are a symptom of deeper systemic challenges, including weak credit assessment, politically motivated lending, and inadequate recovery mechanisms.

Rather than implementing measures to address these root causes, the focus has often been on short-term fixes, which tend to exacerbate the problem. For instance, previous reform programs, such as the Financial Sector Reform Programme in the 1980s, introduced loan classification systems that have arguably contributed to today’s crisis.

International Context and IMF Pressure

The stricter classification policy reportedly stems from conditions imposed by the International Monetary Fund (IMF). However, the IMF’s recommendations may not align with the current realities of Bangladesh’s banking sector. Developed nations have adopted more flexible strategies during crises, often prioritizing financial stability over rigid adherence to policy.

For example, in response to rising interest rates in recent years, many developed countries allowed borrowers to maintain previous repayment terms to avoid a cascade of defaults. Such flexibility prevented economic destabilization despite deviating from standard practices.

The Risks of Timing

Implementing stricter NPL regulations during a period of economic strain could have severe consequences. Businesses struggling to stay afloat may find the reduced grace period unmanageable, leading to a sharp increase in defaults. This, in turn, would erode banks’ financial health and limit their ability to lend to new ventures, stifling investment and economic growth.

Moreover, the potential impact on businesses and the broader economy cannot be ignored. A hardline approach risks creating a domino effect, where businesses unable to repay loans are forced to shut down, triggering job losses and a decline in economic activity.

A Balanced Approach

Instead of tightening regulations across the board, Bangladesh should adopt a more nuanced approach to address the NPL crisis:

• Segregate NPLs: Separate unrecoverable loans and politically influenced bad loans from those with recovery potential.
• Flexible Repayment Plans: Engage borrowers with viable businesses to create tailored repayment plans based on their financial capacity.
• Strengthen Credit Assessment: Improve loan approval processes to prevent future defaults.
• Innovative Recovery Strategies: Introduce mechanisms to incentivize voluntary repayment, such as interest rate adjustments or partial write-offs for compliant borrowers.

Conclusion

Bangladesh’s banking sector must tackle its NPL problem, but timing and strategy are critical. Stricter policies, especially during economic turbulence, could backfire, pushing the sector further into crisis. The solution lies in understanding the unique challenges of the local banking and economic landscape and adopting flexible, long-term measures. By prioritizing stability and sustainable growth, the country can address its NPL crisis without endangering its broader economic prospects.