|The Recovery of Bad Debts Dont leave it to
By R. M. B. Senanayake
Bad debts or non-performing loans in the jargon of the bankers, is a common feature of banks in several countries like Thailand, Malaysia, Indonesia, South Korea and Japan. But there is a difference between the bad loans faced by the banks in those countries and the bad loans in our banks. In those countries the banks were carried away by the booms in property values as in Japan or in their stock markets as in Thailand, South Korea and Indonesia. But our very own bad loans are due to a variant of banking in this country which can be best described as political banking, where loans are given to businessmen and not so businesslike men because of interventions by the ministers and other political worthies who occupy positions of power.
The expressed desire of such ministers is taken as an order by the managements of the two state owned banks. So massive loans have been given to business cronies of the ministers, particularly of the Minister of Finance of the time. A close parallel is of course in Indonesia where Suharto and his family borrowed heavily to set up business conglomerates which spanned more or less the whole of organised economic activity. But the real parallel is Mexico of the 1930s when the Revolutionary Party the PRI of Mexico seized power and held on to power for nearly 70 years until the election of the present President Vincente Fox.
The PRI in Mexico established a totalitarian regime which controlled every aspect of economic activity in favour of the political party, which meant in practice in favour of the politicians and their henchmen. The PRI converted the state owned banks into lending institutions of the party. Many large loans were given to new businessmen the petty traders who were behind the party. In the 1960s when the Peoples Bank was set up, one of the finest bankers produced by Bank of Ceylon was appointed as the General Manager. He set about organising the Peoples Bank and canvassed the customers of the Bank of Ceylon to bank with the newly formed Peoples Bank.
He was soon disappointed when the minister in charge brought pressure on him to give large loans to petty traders who were the close supporters of the SLFP. A Commission of Inquiry was established to inquire into the malpractices during the regime. Its report was published but the politicians or the banking community has learnt nothing. The Peoples Bank continued its political lending. The businessmen who profited from such loans have not been successful since money; even borrowed money, which is not repaid, is not a passport to business prosperity in a market economy. The Bank is now bankrupt being in the red to the extent of Rs. 6 billion in its net worth.
The Bank of Ceylon, an institution that functioned successfully in the private sector competing with the foreign banks and which the country could be proud of, fell on evil days with the nationalisation of the bank in the early 1960s. But the prevailing socialist ideology stressed the need to nationalise and exert state control over the commanding heights of the economy. The problem with state ownership is that the institution belongs to everybody and to nobody. There is the problem which economists call the principal-agency relationship. There is no way to ensure that the management will act in the interests of the owner-shareholder who is impersonal and not interested in controlling the managers to ensure that the bank works in the interests of the owner-shareholder.
Since profit was considered important, even looked upon as a dirty word, there was no maximisation of profits as a yardstick to measure success or failure. Given the impersonal ownership the control of the managers is inadequate and there is no way to align the self-interest of the managers with that of the shareholder through the directors who again are mere nominees who lose nothing if the bank performs poorly. So by the early 1990s both state banks had suffered serious capital erosion. It was necessary to re-capitalise both banks. The government issued bonds to re-capitalise both banks. In the case of the Bank of Ceylon, the government issued Re-structuring Bonds amounting to Rs. 13 billion in consideration of Rs. 9.6 billion as re-capitalisation and another Rs. 3.9 billion in settlement of loans given by the bank to state organisations which were guaranteed by the government.
The bonds have a maturity of 30 years from 1993 and cannot be sold. The bonds may be cancelled to the extent of the dividends payable to the government and retained by the bank. The bank earned interest on the re-structuring bonds, which in 2001 amounted to Rs. 2.1 billion, which was a significant 40% addition to the net interest income of the bank.
In 1996 Bank of Ceylon was given a further Rs. 9.3 billion worth of re-structuring bonds to settle liabilities guaranteed by the government. These bonds carry an interest rate of 14% per annum.
No recovery of bad loans
The government obtained no commitment from the state banks that they should recover the bad loans by selling off the security pledged by the defaulting borrowers. It left this task to the two banks. In every other country where the government re-capitalised the banks they insisted that selling off the security and suing the borrowers for the balance to recover the bad loans. Nor was any attempt made to separate the bad loans from the rest of the loan portfolios. The practice in other countries is to separate such bad loans and vest them in a Reconstruction Corporation or Asset Management Company. This new agency was vested with the task of recovery of the loans. They could also sell such bad loans to other parties at a discount and the buyers inherited all the rights of the banks.
This recovery agency could also recover the loans by selling the security after foreclosure. They could also institute legal proceedings against the defaulters. They could re-structure the business concern of the defaulter without going through the normal provisions of company law governing amalgamations or reconstitution or reorganising of a company. So the governments of the Asset Management Organisations not only take over the bad loans but recover them as well. If there is one lesson that the government should have learnt it is that the banks cant be left to recover the bad loans. By taking the bad debts off the balance sheets of the banks the government restores the banks to good health and they could re-commence normal lending without having to worry about the past bad loans. This is the way to clean up the balance sheets of the banks, which has been adopted all over the world. They have functioned with varying degrees of success in recovering loans.
According to the Economist of 4/1/03 Malaya has recovered 29% of the fair value of such loans and expects to recover 57% on completion. The Thai government originally left the recovery of bad loans to the banks themselves. But when they found that little progress was made, a new government set up the Thai Asset Management Corporation in 2001, a rather belated exercise. Indonesia set up the Bank Re-structuring Agency. One of the criticisms of these organisations is that their dealings lack transparency and that they give preferential treatment to favoured businessmen. There are also allegations of corruption, particularly against the Indonesian agency. As the Economist says "For one reason or the other, the officials keep softening the repayment terms of the same financier who not only ruined their banks during the crisis but also filched $20 million of government money earmarked for re-capitalisation." One hopes the Bank of Ceylon doesnt follow the same trail since the re-structuring bonds were issued to it. The Peoples Bank of course has done just that- to lose the money given for re-capitalisation.
A recent newspaper report said that an Asset Management Corporation is to be set up in our country as well but that the president has held up the Bill to be presented in Parliament. Perhaps the government has at last realised that the task of recovering bad loans even partially cannot be left to the two state banks. But why is the president holding up the Bill? What the president must ensure is not only that such an agency should be set up but also that it operates on a non-political basis recovering the bad loans of errant businessmen whether they belong to the UNP or the SLFP. Its directors and CEOs must be appointed by the Constitutional Council to provide for some independence, at least theoretically, to those in charge to discharge their job impartially without favouring those defaulters of the ruling party.
The agency must be given clear objectives such as the disposal of all the loans and
assets perhaps beginning from the largest debtors as speedily as possible while obtaining
the best return from the sale of assets, the sale of the loans themselves or the
re-structuring of the debtors business. It must not get into running any of the businesses
taken over or retaining the lands foreclosed for default. The transactions should be
transparent and entirely business-like.
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