Internship Report on Non-performing Loans of Commercial Banks in Bangladesh
Subject: Business, Finance | Topics:

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 10.80 % of total loans is 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 10.80 %, still it is much higher than the internationally accepted tolerable range and, thus, is a threat to our banking sector.

It is obvious 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. All those adverse impact of NPLs on banks’ financial health such as low profitability and low capital base are clearly reflected in Bangladesh banking sector. The question arises as to why we are unable to solve this problem for such a long time? A number of studies have been undertaken to deal with the problem and to address this ‘default culture’ phenomenon. Emergence and accumulation of high scale of non-performing loans after independence starting from the nationalization of banks has been well discussed by a number of authors. Several attempts have been made to explain the non-performing loans problem with some theories relating to political economy backed by empirical findings. Islam et al., (1999) in their study on bank loan default offered the idea of ‘comprador government’ and ‘comprador bourgeoisie’ developed by Paul Baran as an explanation of the behavior of Bangladeshi capitalists class where trading as opposed to manufacturing becomes the main business of the capitalists and they act as importers, indentors, sales agents, suppliers, etc. The same study also made an effort to explain the process of transfer of economic surplus through international trade based on Emmanuel’s theory of ‘unequal exchange’ which complements Baran’s explanation. Ahmad (1997) used three theoretical paradigms in his quest for a socio-political explanation of the bank loan default problem of Bangladesh, the rational actor theory, the pluralist instrumentalist theory and the organizational bargaining theory. Based on an investigation he mentioned some important factors as causes of loan default which includes lack of willingness to pay coupled with diversion of fund, willful negligence and belief that waiver may be available in the future, operational problems, inability to utilize production capacity, power failure, improper credit appraisal, natural calamity, and unfair taxation. Non-professional handling of assets both by the State-owned Commercial Banks and the private sector bank was reported as the main reasons for the accumulation of loan default problem in Bangladesh (Alam and Jahan, 1999). It included the Government directed credit for the loss making public sector enterprises and the private sector banks’ lending to insiders and connected parties. Prof. Rehman Sobhan (1991) in his study on debt default problem examined the nature and problems relating to poor repayment status of the two Development Finance Institutions- Bangladesh Shilpa Bank and Bangladesh Shilpa Rin Sangstha.

The problem of non-repayment could have been minimized if there were sound and effective legal recovery mechanism. But, at least, until very recently the enforcement status of lender’s recourse related (Money Loan Court Act, Bankruptcy Act, PDR Act) laws were weak. However, legal recovery got momentum after a major revision in the Money Loan Court Act, 2003. As on December 30, 2007 a total of Tk.34.27 billion was recovered against the claimed amount of Tk.66.65 billion under the Money Loan Court.

1.2 Objectives of the study:
The objectives of this paper is
i. To assess the present situation of non-performing loans in our banking sector
ii. To show the trend of the “loan default problem’’ in Bangladesh
iii. To examine the loan default status of commercial banks
iv. To discuss legal aspect to recover loans from the defaulters
v. To identify the causes and remedies of non-performing loans and
vi. To raise some issues and observations which need to be looked upon quickly for ensuring a financially sound banking sector.

1.3 Methodology of the study
The research methodology of the study has been enumerated below:
a. Sources of Data and Data Collection
Data has been collected from the various secondary sources like research works of individuals, different publications, journal of different institutions, reading materials, books, library sources, Bangladesh Bank, CRG manual etc.
b. Time Preference
The time preference of the study relates to the period covering the years 1990 to 2008. These 19 years has been taken for different analysis purposes.
c. Data Processing and Analysis
Data processing has been done manually after checking and editing. Tabular techniques are used to present data in this paper.

1.4 Scope and Limitations of the study
Non-performing Loan is very much important for the banking sector. Here the study would concentrate on laws and regulations and existing legal structure as well as status of NPL of different commercial banks. Problems are always there for any research study. Effort was there to overcome the limitations and to bring a reliable and fruitful result. The limitations of the study are;
This study did not cover primary and unpublished data.
The major problem faced while conducting the research was unavailability of relevant data.
Time constraint.

1.5 Structure of the Study
This research report has been divided into seven parts. In the first chapter, introduction of the research have been given. Here the background, objectives of the study, methodology and scope has been elaborated. In the second chapter, the conceptual framework and review of the literature are described. The third chapter portrays the trend of the loan default problem in Bangladesh. The fourth chapter illustrates the loan default status of commercial banks. The fifth chapter describes the descriptive analysis of related laws and impact of new regulations. The sixth chapter identifies the causes and remedies of non-performing loans. Finally the seventh chapter contains the findings, challenges and concluding remarks of non-performing loans.

Conceptual Framework and
Literature Review

2.1 Definition of classified loans
Loan becomes non-performing when it cannot be recovered within certain stipulated time that is governed by some respective laws. So, non-performing loan is defined from the institutional point of view, generally from the lending institutions side. Loan may also be non- performing if it is used in a different way than that for which it has been taken. This is the users point of view. But, here we will confine the definition to the institutional point of view. Loan classification means giving each and every loan case a status unclassified, sub-standard, doubtful or bad loss through verification of borrower’s repayment performance on particular date while provisioning means setting aside fund from the profit (profit before provision and taxes) against possible loan loss. This is obviously essential for determining the financial health and efficiency of the banking sector. Besides, a proper loan classification and provisioning system ensures credibility of the financial system that in turn restores trust and confidence in the minds of the depositors. In this case, loan becomes non-performing when it is classified as bad and loss for which Bangladesh Bank requires 100% provisioning by the scheduled commercial banks (as per BRPD circular). Under Basel-II, loans past due for more than 90 days are non-performing.

The National Commission on Money, Banking and Credit conducted a study with the help of the World Bank and on the basis of its report; the government introduced a comprehensive financial sector reform program in the country. As part of this program, a new system of loan classification and provisioning against potential loan losses for advances was introduced in November, 1989. Before 1989 no specific guidelines were followed by the commercial banks for this purpose. In 1989 Bangladesh Bank issued BCD circular No. 34 stating specific rules and conditions of loan classification. After that each scheduled banks except BKB, RAKUB and BSB would be responsible for its own classification according to the guidelines stated in this circular.

This process was continued till 1994. Bangladesh Bank further issued a circular in 1994 (BCD circular No, 20/1994). The title of the circular was “Revised Rules of classification and provisioning of loans and advances”, which came into effective from 31st December, 1994. The introduction of this program was aimed at to bring loan loss provisioning and classification in line with international standards by the end of 1994.

2.2 Kinds of default loans
The loans are usually classified by the lending bank, whenever the bank has reasons to believe that the borrower would not be able to repay the loan regardless of whether the loan is overdue or not. Loans extended by a bank are classified into the following three categories.
i. Substandard: Advances which appear substantial degree of risk to bank by reason of unfavourable record or other unsatisfactory characteristics.
ii. Doubtful: Advances the ultimate realization of which is doubtful and in which a substantial loss is probable.
iii. Bad/Loss: Advances which may not be recoverable at all and entire loss is probable.

2.3 Provisions
The base for provisions on non-performing loans is the balance outstanding in the loan ledger for the loan, less any interest taken in an interest suspense account.

According to BRPD circular No. 09 dated May 14, 2001 either of these continuous, demand and fixed term loans will be classifying and provisioning by following procedure:

Table 2.1: Default loan provisioning
Loans Duration of overdue Provision (% of
outstanding loans)
Unclassified Less than 6 months 1
Substandard 6 months to 9 months 20
Doubtful 9 months to 1 year 50
Bad More than 1 year 100

To reach the international standard the central bank has tightened loan-classification regulations under which loan repayments overdue for three months will have to be shifted to ‘Special Mentioned Accounts’ of the banks. At present, if a loan repayment is over due for six months, it is considered classified. The new regulation became effective from March 31, 2005 will offer an interim warning period of three months before turning the loans into classified loans. It mentioned if borrowers fail to repay their debts within six months tenure, the loans will become classified and they will then be enlisted with the Bangladesh Bank’s Credit Information Bureau (CIB). The defaulted borrowers will not be able to get fresh loans afterwards. Instead, the banks will have to pay the first penalty. The banks will not be allowed to incorporate the interest of such loans in their income after three months. However, the banks need not to create provisions against these types of loans for the next three months, in case the borrowers continue not to pay.

2.4 Literature review
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. Choudhury et al. (2002: 21-54) state that the nonperforming loan is not a “uniclass” but rather a “multiclass” concept, which means that NPLs can be classified into different varieties usually based on the “length of overdue” of the said loans. 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 (Woo, 2000: 2). 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” (Bernanke et al., 1991: 204-248).

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. Muniappan (2002: 25-26) argues that a bank with high level of NPLs is forced to incur carrying costs on non-income yielding assets that not only strike at portability but also at the capital adequacy of a bank, and in consequence, the bank faces difficulties in augmenting capital resources. Bonin and Huang (2001: 197-214) also state that the probability of banking crises increases if financial risk is not eliminated quickly. Such crises not only lower living standards but can also eliminate many of the achievements of economic reform overnight. The economic and financial implications of NPLs in a bank-centered financial economy can be best explained by the following diagram:


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.

The issue of nonperforming loans in Bangladesh is not a new phenomenon. In fact, the seeds were cultivated during the early stage of the liberation period (1972-1981), by the government’s “expansion of credit” policies on the one hand and a feeble and infirm banking infrastructure combined with an unskilled work force on the other (Islam et al., 1999: 35-37). Moral et al. (2000: 13-27) argue that the expansion of credit policy during the early stage of liberation, which was directed to disbursement of credit on relatively easier terms, did actually expand credit in the economy on nominal terms. However, it also generated a large number of willful defaulters in the background who, later on, diminished the financial health of banks through the “sick industry syndrome”. Islam et al. (1999: 22-31) add that despite the liberalizing and privatizing of the banking sectors in the 1980s with a view to increasing efficiency and competition, the robustness of the credit environment deteriorated further because of the lack of effective lenders’ recourse on borrowers. Choudhury et al. (1999: 57) find that Government direction towards nationalized commercial banks to lend to unprofitable state owned enterprises, limited policy guidelines (banks were allowed to classify their assets at their own judgments) regarding “loan classification and provisioning”, and the use of accrual policies of accounting for recording interest income of NPLs resulted in malignment of the credit discipline of the country till the end of 1989.

In the 1990s, however, a broad based financial measure was undertaken in the name of FSRP, enlisting the help of World Bank to restore financial discipline to the country. Since then, the banking sector has adopted “prudential norms” for loan classification and provisioning. Other laws, regulations and instruments such as loan ledger account, lending risk analysis manual, performance planning system, interest rate deregulation, the Money Loan Court Act 1990 have also been enacted to promote sound, robust and resilient banking practice. Surprisingly, even after so many measures, the banking system of Bangladesh is yet to free itself from the grip of the NPL debacle. The question thus arises, what are the reasons behind such a large proportion of nonperforming loans in the economy of Bangladesh? Is it because of “flexibility in defining NPLs” or lack of effective “recovery strategies” on the part of the banks? Alternatively, is it due to poor enforcement status of laws related to nonperforming loans? The present study has concentrated on the above issues mainly with a view to assisting policymakers to formulate concrete measures regarding sound management of NPLs in Bangladesh.

2.5 Base for provisioning and accounting treatment of NPLs
The bank managers of Bangladesh deduct the amount of interest suspended and the value of “eligible securities” from the outstanding amount in order to determine the base for provisioning to NPLs. For unclassified loans, however, they keep a general provision (1%) against the outstanding amount and include it in the capital to determine the capital adequacy of the bank (at present 10%). With regard to income recognition, bank managers do not consider the amount of interest on substandard and doubtful loans as income for the bank, but rather keep it separately in an “interest suspense account”. However, if any amount is received against sub-standard and doubtful loans, the said amount is deducted from the total interest suspense amount. In the case of a bad/loss loan, the interest on such loan is also kept in the interest suspense account if a suit is filed in the court. Seemingly, with regard to substandard and doubtful loans, this interest is also excluded from the income of the bank. These accounting measures have made the banking sector more transparent and credible than they were in the past.

Trend of the Loan Default Problem in Bangladesh

3.1 Emergence of Default Loans
As banking remains the main intermediary vehicle of harnessing investible capital for accelerating the growth of the productive sectors in Bangladesh, the continuing crisis of accumulation of non-performing and defaulted banks loans has emerged as one of the most serious constraints in the path of economic development of our country. Now we will discuss how the loan default problem has emerged in our country by year-wise.

3.2. Pre-liberation period
Before the liberation of Bangladesh, the economic development policies of Pakistan was centered around growth-oriented ‘modernization paradigm’, wherein industrialization was assigned the top priority in the allocation of investible funds from the institutional credit sources in the name of providing employment to the vast multitude of the so-called ‘disguisedly unemployed labour force’. This attempt of development of an industrial entrepreneurial class in Pakistan miserably failed to provide adequate quantum of formal industrial employment even in West Pakistan. This is regarded as one of the main factors behind the rapid growth of ‘regional economic disparity’ between the two Pakistan. Then banking was blamed as a principal mechanism of siphoning-off capital from the East Pakistan and therefore nationalization of the banks and insurance companies became one of the most popular issues in the election manifesto of the Awami League during the 1970 election of Pakistan.

3.3 Post liberation period
After the liberation of Bangladesh, the Awami League Government’s decision to nationalize the banks and insurance companies operating in Bangladesh should be considered a logical step but the task of re-organization of the nationalized banks in the chaotic, war-ravaged and crisis-ridden post-liberation years and a very rapid expansion of banking network in rural Bangladesh created some problems for the banking sector. There was no time after nationalization as the most corrupt, undisciplined, over manned and mismanaged concerns mired in sea of recurrent losses in the backdrop of the political and administrative inexperience of the post liberation regime.

In this scenario, the nationalized banks were involved in two sorts of pressure situations, firstly, the almost insatiable demand for credit from the loss making state-owned enterprises kept the banks under constant pressure due to a shortage of adequate liquidity and secondly the newly emerging so called “briefcase business man” with connection with politics and politicians, top bureaucrats and top bankers, and retired military and civil bureaucrats were constantly lobbing for access to bank credit and in the process were vitiating the work atmosphere in the banks by alluring a section of the banker to indulge in corruption and malpractices. It is now widely recognized that today’s millionaires of Bangladesh came mostly from the Ranks of those “briefcase businessman” and the groups mentioned, who could successfully establish and maintain this types of patron clients relationship with the bankers and in the process created a host of millionaires from amongst those bankers themselves, who had actively connived and harvested the illicit margins in exchange of the favours rationed out to those fortunate loanees.

The political changes of 1975 ushered in an era of political culture, where in corruption gradually became institutionalized, the economics of rent seeking took firm roots in the body politic of Bangladesh. In the process, sanctioning of bank loans became one of the prime victims of the buying and selling process afflicting the political party affiliation process, and a popular mechanism for doling out financial favors to party leaders as well as political cadres. This politicization of the banking practices has seriously hampered the institutional disciplines of the banks, where professional expertise, integrity and ethical values have become exceptions to some extent rather than rules. Ex-banker emerged as financiers as the newly floated private banks, but there was no mechanism to make them accountable or to know about the sources of their cash. Defaulters of bank loans taken from nationalized banks or state-owned development finance institutions swelled the rank of directors of the newly established private banks, but nobody intervened on behalf of the loan-giving banks caught in the middle with defaulted loans. The laws, rules and regulations relating to banking remained mostly in the books; and the judicial process utterly failed to take the willful defaulters to task, thereby making the process of lender’s recourse on borrowers almost a mockery in Bangladesh. Therefore, we surmise that behind all these malaises, the nature of the sate and of politics played the real villainous role by patronizing and developing a class of ‘comprador bourgeoisie’ in Bangladesh, created, nursed and constantly nourished by state-patronage, and in this nursing process, bank loans were rampantly used as lucrative doles.

In the eighties, the rapid liberalization of Bangladesh’s import regime has created the so-called ‘sick-industry syndrome’, which provided a potent excuse for some, and created genuine hardships regarding repayment of bank loans for the other. The domestic industries have been bearing the burnt of this ill advisedly too rapid pace of liberalization of Bangladesh’s international trade without appropriate preparatory policy measures. The political doldrums of the late-eighties provided additional excuses to these swelling groups of defaulters. The BNP government of 1991-96 tried to stem the rot in this field in the initial years of its term. They repeated the blunders of its predecessor of providing lavish encouragement to bank managements to ease and expedite the process of term lending, especially according to its own political exigencies at the later stated of its rule, which added a massive amount of fuel to the fire of the so-called ‘default-culture. And earlier lending sprees continues to haunt the banking section even today be sustaining the momentum of the build-up of the defaulted loans of the earlier two decades.

3.4 The Present status of Loan Defaults Culture in Bangladesh
As loans comprise the most important asset as well as the primary source of earning for the banking financial institutions and on the other hand also the major source of risk for the bank management so a prudent bank management should always try to make an appropriate balance between its return and risk involved with the loan portfolio. But Banking sectors recent involving activities, guidelines and their concentration in that is not satisfactory.

The prudential guidelines also call for making adequate “provisions” against classified loans in order to protect the financial health of the banks are prepared but which is meaningless as by making provision the number of willful defaulters increasing day by day. The economic implications of the non-performing/default loans are not only stoppage of creating new loans but also the erosion of banks profitability, liquidity and solvency, which might sometimes leader towards collapse of the baking financial system. It has therefore become sine qua non for policy makers to study the loan default scenario of the banking sector of routine basis for estimating classified loan, making appropriate provisioning, adopting effective recovery strategy and thus ensuring soundness and efficiency of the banking sector.

Before privatization and liberalization this banking activities were thus directed to disburse credit, according to the government’s economic priority, and hence little attention was placed to identify the problem loans and making provisions thereon, although there was significant amount of hidden default loans. After 1982, the banking sector of Bangladesh underwent a rapid denationalization and privatization process. The out of six nationalized commercial bank Uttara Bank and Pubali Bank were denationalized in 1983 and 1984 respectively with a view to increasing the efficiency of the banking sector. Henceforward, private bank were allowed to conduct banking operations in order to increase, competition, reasons, the efficiency and productivity of the banking sector. But due the various reasons, the efficiency of the banking sector did not increase rather the credit discipline was further eroded.

The most important aspect of this study is to measure the magnitude of loans classified substandard, doubtful and bad/loss since the adoption of criteria for overdue loan classification in 1990. In connection to this, it must be mentioned that banking system in Bangladesh (as on December 2003) comprises four types of scheduled banks-nationalized commercial banks (NCBs), government-owned development financial institutions (DFIs), private commercial banks (PCBs) and foreign commercial banks (FCBs)-for catering to the credit needs of the economy. Therefore date on classified loans in both the banking sector as a whole and in different clusters of banks are taken into account to gain a clearer picture of the NPL issue.

Loan Default Status of Commercial Banks

4.1 Loan classification system in use in Bangladesh
Since 1989, Bangladesh follows both “overdue criteria” and “qualitative criteria” to deem a loan classified or unclassified. According to overdue criteria, as suggested by Bangladesh Bank, bank managers usually divide all loans into five categories (continuous loan, demand loan, term loan payable within five years, term loan payable in more than five years and short-term agricultural credit/micro credit), and then observe periods elapsed for repayments. All troubled loans are then further reclassified as special mention account (SMA), substandard, doubtful and bad/losses to comply with international norms of loan classification. Further, in order to keep the management up to date about the status of loans, bank managers review the loan quality on a quarterly basis. With some exceptions, the banking sector at present follows a norm of six months overdue for deeming a loan nonperforming. The rate of provision on classified loans follows norms of 5%, 20%, 50% and 100% against special mention accounts, substandard, doubtful, and bad/loss loans respectively. The current loan classification and provisioning system (in a summary form) in use in Bangladesh is shown below in

According to the qualitative judgment criteria, bank managers classify any loan if it forecasts the uncertainty of recovery of the loan due to the following reasons:
a. Credit extended without approval of competent authority or without any logical basis (under pressure).
b. Incomplete documentation.
c. Insufficient security or drastic fall in the value of security.
d. Borrower sustains heavy loss in capital due to natural calamity or business condition.
e. Frequent overdraw of limit
f. Rescheduling terms are not maintained.
g. Borrower cannot be traced or death of the borrower.
h. Filing a suit against the borrower for recovery of credit.

4.2 International standard of loan classification and the status of Bangladesh
Being a member country of the World Bank, Bangladesh needs to compare its loan classification and provisioning system with the international standard. In order to facilitate the same, the standard international system of loan classification and provisioning is shown below in Table 4.2.
Table 4.2: Loan Classification System (International Standard)


In comparison to the international standard of loan classification and provisioning, it is found that the banking system of Bangladesh follows 4 stages (SMA, sub-standard, doubtful, bad and loss) to define the status of a classified loan, as opposed to three stages (sub-standard, doubtful, bad and loss) used in the international standard. While the international standard provides the norm of 3 months overdue for terming a loan substandard, this period is used in Bangladesh as the norm for terming a loan a “special mention account”. In addition, Bangladesh shows more flexibility than the international standard in the classification of long-term loans. However, in the case of provisioning and frequency of classification, Bangladesh follows the international standard to a great extent. In the final analysis, it can be concluded that the present loan classification and provisioning system in use in Bangladesh is similar to a great extent to the international standard, although it is yet to adopt the international standard completely.

4.3 Present Status of Non-performing Loans
The banking sector in Bangladesh passed through significant changes in terms of structure and policies especially since the 1990s. After independence, Bangladesh accumulated huge amount of non-performing loans (NPLs) due to various reasons e.g., politically motivated credit disbursement and build up of bad loans in state owned enterprises (SOEs) due to corruption, inefficient management, and low technical skills. Besides, the persistence of relatively high interest rates contributed to increase in NPLs in the country.

Among the classified loans, bad/loss loans constitute about 81.1 percent. The total classified loan ratio declined markedly from 41.0 percent in 1999 to 10.8 percent in December 2008 (Table 4.3). In December 2008, the sub-standard category of loans as a percent of total classified loans declined to 9.4 percent, while doubtful loans increased from 7.5 percent in December 2007 to 9.4 percent in December 2008.


The gross classified loan in total loan outstanding stood at 10.8 percent in December 2008, which was 12.3 percent at the end of September 2008. The classified loans outstanding of NCBs and SBs were 25.4 percent and 25.5 percent respectively in December 2008 compared with 29.3 percent and 26.2 in September 2008. The classified loan outstanding of PCBs declined to 4.9 percent in December 2008 from 5.4 percent over the previous quarter. For the FCBs, classified loan was 1.9 percent in December 2008 rising from 1.6 percent over the previous quarter. Both NCBs and SBs are burdened with large amount of NPL loans (Table 4.5). Among the SBs, BSRS has the highest NPL (44.1 percent) followed by RAKUB (34.5 percent), BSB (32.9 percent) and BKB (28.2 percent), while among the NCBs, Sonali Bank Limited has the highest percentage of NPL (33.3 percent) followed by Rupali Bank Limited (32.5 percent), Agrani Bank Limited (24.6 percent) and Janata Bank Limited (10.9 percent). All the PCBs have non- performing loans below 10 percent except for ICB Islamic Bank Limited (80.7 percent), BCBL (28.1 percent). All FCBs have non-performing loans below 4 percent.

Table 4.4 shows the trend of classified loans out of new loans for all groups of banks. The flow of new classified loans declined because of adoption of measures both by the banks and BB (including appointment of private recovery agents, paying commission to lawyers, incentives to bank staff and real estate brokers, establishment of Money Loan Court in 2003, and strengthening of BB’s supervisory role) to improve the NPL situation.


In Bangladesh, a major concern for the monetary authority is the adverse effect on bank balance sheets arising out of high NPLs of the banks. Along with other measures, Bangladesh needs to strengthen asset management companies to quicken recovery and improve efficiency in the banking sector. The BB’s recent directives to the banks to take precaution while extending loans to high risk sectors and prioritize loans to productive sectors in conjunction with the government’s enactment of laws prohibiting loan defaulters to take part in elections at local and national levels and similar other measures would help to further improve the NPL situation in the country.

Chapter –Five
Legal Measures to recover the default loans

5.1 Enforcement status of laws relating to the default loans in Bangladesh
There is a famous maxim “justice delayed is justice denied”. This can be applied to banks, especially in developing countries like Bangladesh, owing to the presence of corruption and opaqueness in the settlement process as well as poor enforcement of laws that usually create a fertile ground for the willful defaulters. In the case of Bangladesh, although several laws have been enacted and amended with a view to ensuring the safety and soundness of the banking system, the banking sector still witnesses an alarming amount of NPLs. Therefore, it would be meaningful to measure the actual performance of different courts in terms of number of suits filed, rate of settlement and rate of recovery of NPLs over the years.

5.2 The performance of Artha Rin Adalat
The Artha Rin Adalat Act was enacted in 1990 to address separately all issues related to NPLs, with the objective of ensuring the safety and soundness of the banking system.

An analysis of the performance of this court reveals that the number of suits filed, amounts claimed and number of settled suits have all increased considerably from 1995 to 2008 (Table 5.1). It is also encouraging that the percentage of settled suits has increased considerably from 11.59% in 1995 to 37.71% in 2005, then to 43.30% in 2008. Unfortunately, the recovery rate is seen to be very slow and is confined to 6%-8% only during the last several years. Thus, the slow execution of the decrees in Bangladesh can be seen as the main factoring contributing to very low recovery of NPLs.


5.3 The performance of the Bankruptcy Act and the PDR Act
The Bankruptcy Act of 1997 was formulated in order to assist the recovery environment and to enable speedy recovery of NPLs in Bangladesh. An analysis of the performance of the bankruptcy court shows that the recovery rate is only 1.12% against Tk.254662 crore in 2008 (Table 5.2). The recovery rate of cases settled through the PDR court is also seen to be unsatisfactory (46.02%), although it shows better performance than other courts. Therefore, the main hindrance relating to the recovery of default loans at this moment seems to be the poor enforcement status of laws and slow execution of decrees. In this connection, it must be mentioned that the law itself is not solely responsible for delay in settlement of cases related to NPLs; rather, a number of parties such as plaintiffs or complainants, defendants, lawyers and judges are also involved in the process.

Table 5.2: Status of Suits Filed and Settled in the Bankruptcy Court, PDR Act and other Courts as of 30 June 2008
(Tk. in Crore)

Name of the Courts No. of suits filed Amount claimed No. of settled suits Amount recovered % of settled suits Recovery rate
Bankruptcy Court 464 254662 155 2874 33.40 1.12
P.D.R. Act 647424 96957 468225 44626 72.32 46.02
Source: BRPD, Bangladesh Bank, 2008.

5.4 Measures Adopted for Reduction of NPLs in Bangladesh
Bangladesh has adopted many punitive measures to curb and recover nonperforming loans. Hence, it is important to discuss all these measures adopted for better policy framework and effective management of NPLs. The measures are summarized in Table 5.3, below.

The Causes and Remedies of Non-performing Loans

6.1 Causes of Loan Default Problem


A1: Young Age
Young age is one of the reasons behind the failure of payment of regular loan. Because of young age people suffer from lack of business experience. On the other hand they normally don’t have enough banking experience. As they are young and lack experience, it may be one of the reasons of default loan.

A2: Lack of business experience.
Sometimes people without prior business experience want to do something. It may so happen that after retirement from govt. or private service people want to establish a business, which is not very relevant to his past experience. Besides his own equity they look for bank finance. Normally banks do not finance in the projects where the key personnel do not have enough background in that particular business. When banks finance in the projects here the key personnel lack relevant business experience, it becomes risky for the bank. Probability of failure in these sorts of projects tends to be higher.

A3: Lack of Business and Lack of Institutional Training Background.
Business experience is somehow related to business background. Here business background means family business background. Though family business has a role in entrepreneurial orientation, there is no direct relationship between business background and business performance of loan repayment. It is true that youths coming from business background are familiar with business and banking but there are other ways to get oriented with the same, not necessarily one has to come from business family.

A4: Unwillingness to Pay.
We all know this is one of the most common reasons behind default culture in Bangladesh. It can happen in some situations like when security-backing loan is weak; customer feels that defaulting the loan will not harm him much. In that case he tends to default. In other cases like when cash flow from the business is not impressive, people are unwilling repay the loans. Even sometimes without any reason customers default loan that purely psychological and absolute unwillingness to repay loan.

A5: Lack of Supporting Facilities
Sometimes business need support from other sources. When cash flow is lean and the project is in lull, it needs feeding. Without further feeding company may become sick and incur loss in consecutive time periods. In our country most of the companies do not have the supporting sources with which they can withstand the turmoil that comes in to their business from time to time.


B1: Non-attractive Industry
Sometimes non-attractive industry acts as primary cause of loan default. Companies operating in non-attractive industries have higher probability of performing poor. Because of poor financial performance, company’s cash flow gets affected. Because of cash flow the company becomes less liquid which contributes in defaulting bank loan. Not necessarily that all the companies no non-attractive industry perform poor.

B2: Strong Competition
Strong competition does not directly contribute in defaulting loan. Strong competition takes place when many companies enter into an industry where the industry cannot accommodate so many companies. In strong competition only efficient players survive. So the inefficient companies find it difficult to make profit and sale their product. Once they fail to make profit, the company is likely to default its loan installment in the bank.

B3: Poor Management capability
Before sanctioning a loan banks look into the matter that how the management of the company is. If the bank feels that the management is capable enough to successfully run the business and utilize bank finance, then bank agree to finance otherwise not. Even sometimes banks sets conditions like some of the key personnel must not quite the organization before repayment of the loan. Managerial capability plays vital role in repaying bank loan. The more professional the management is, the less is the probability of defaulting loan.

B4: Poor Financial Performance
Definitely poor financial performance is the most important cause of loan default. Once a company is not solvent, it is unlikely to repay its loan. Poor financial performance is the key reason behind maximum loan default. Poor financial performance can be arisen from many other reasons described above.

B5: Poor Cash Flow
In most cases poor cash flow is the aftermath of poor financial performance. Because of poor cash flow companies mainly default loan. Because of irregular cash flow, business becomes unstable and illiquid. In that case business does not have enough cash to service loans payment and interest. Even if a company is profitable, the company may default because of cash flow. In some cases, a business may sell most of its finished goods in credit. So it may not have enough cash to support the loan and other debts. So it may cause default.

B6: Low Market Share
Low market share may be a reason of loan default but not a single respondent mentioned it as one of the reasons of their loan default. Low market share means low sales, low sales mean low profit and low profit results default. But operating in a niche market, having a very low market share a firm can be profitable enough to repay its entire loan obligation as well as retain sizable earning.


C1: Delayed Assessment of Loan Proposal
Banks sometimes make delay in assessing loan proposals of the business firms. When the firm badly needs money, it does not get enough funds because of delayed assessment by the bank. This infuses shortage of cash in their business operations. They hardly manage their day-to-day business expenses let alone repayment of the loans.

C2: Delayed Disbursement of Fund
Even after assessment of the proposal and taking positive decision, banks do not disburse funds until security documentation formalities are completed. As a result business do not get fund when actually it requires it. Some of the defaulters complained about subsequent disbursements.

C3: Lack of Proper Monitoring
Monitoring is one of the most important parts in credit. Through monitoring lenders come to know that whether their fund is being used for the desired purpose or not. Sometimes disbursed money is used for purposes other than the specific areas. In that case risk of loan default gets higher. Banks sanction loan on the basis of feasibility of the project. Bank as a lender expect that the loan will be serviced by the cash flow generated from that particular business. But if credit is used in some other areas desired cash flow may not come from the business and chance of loan default gets high. Therefore banks monitor activities of the borrower whether the fund is being properly utilized or business is generating enough cash flow or not. Banks use specialized formats for loan monitoring. Bank periodically review the performance of the borrower and based on that bank decides whether to renew the facilities or not. The tools used for monitoring are portfolio reviews, profitability analysis etc.

C4: Lack of taking Proper Action
Action comes after loan monitoring. Monitoring is done for identifying deviations or exceptions. If there is any exception then corrective action needs to be taken. If corrective actions are taken on time chance of default loan reduces. When Customer misses one installment, concerned officer of the bank must visit the customer and understand where the problem lies. If proper action is taken, probability of loan default is reduced.


D1: Low GDP Growth
It is evident that companies which deal in consumer products are directly affected by the GDP growth of the entire economy. Regular customers and defaulters have opined that this macro indicator influences the cash generation of a company and hence the repayment of the loan.

D2: Increasing Crimes

It is revealed that the effect of the increasing crimes in the business of the companies. They think that forced subscription sometimes make the profitability of the company lower.

D3: Hartals by the Political Parties
Political instability of the country hampers the production and the distribution of the products in a smooth way and the political turmoil is considered one of the other causes of the loan default in our country.

D4: Frequent polity Changed by the Government
Government is considered as the minor cause of the loan default as per the survey since it has a little impact on the local sales and distribution of the products of the companies. Without these are other causes such as imperfect lending practice, lack of analysis of business risks, lack of proper valuation of security or mortgage property, undue influence by borrowers, external pressure, loan go Govt. organization, Govt. policy for disbursement of credit, lack of legal action.

6.2 Indicators and Remedies of Loan Default Problem
Before analyzing the remedies of loan default problems we will discuss the indicators of default loan which would indicate financial trouble and serve s a “red flag” to the financial officer. There are many indicators of default loans but there is no set pattern of frequency of occurrences of events leading upto a point where a loan could be declared a problem loan.

A. Indicators of Default Loan
Delayed submission of financial statements.
Slowness in the ability to arrange plants visits and deterioration in the rapport.
Declining deposit balances and the occurrences of overdrafts and returned cheques.
An unusual rise in inventories and increase in trade payables.
An increase in receivables, this may indicate a lowering in the qualities of the firms products or services, a change in the terms of sale, or the sale to financially weak firms in an effort to increase sales and income.
Irregular payment of the loan.
Expansion through merger or acquisition: merger with another firm or sale of assets.
Change in management or the resignation of key personnel, labor problem.
New financial arrangement or indebtedness.
Natural disasters such as flood, fire etc.

B: Remedies of Default Loans
Keeping in mind the above indicators we can proceed on to find out some remedies. According to Prof. Muzaffer Ahmad (1997) the way out of the current crisis of bank loan default lies in evolution and entrenchment of responsive and participate governance from grass roots upwards which can be instrumental in decartelizing the decision making process. In this visualized governance process the governments will take on itself the task of removing imperfections due to invisibilities, externalities, imperfect access to information, knowledge and resources (Ahmad 19997 P. 43), Bhattacharya (1998) highlights the crucial need of building up a strong financial infrastructure and adequate legal framework for enforcing lenders’ recourse on borrowers, effective supervisory and regulatory role of the central bank through formulation of broad-based prudential guidelines, commercial autonomy of bank management, and institution of readable and transparent accounting base (P-133). He mentions the following reform issues (P-136-143) such as autonomy of Bangladesh Bank should be strengthened and the post governor should be made constitutional, role of banking division of the Ministry of Finance should be reduced, the scheduled banks should be put fully under the regulatory oversight of the Bangladesh Bank (corporate governance of the banks), member of the political parties and defaulters should be barred from the boards of directors of banks, state owned enterprises should be pursued for defaulter loans,, loan amnesty and loan forgiveness undermines financial discipline, PCBS should not bailed out through re-capitalization, which may encourage moral hazard, international standard based audit of the loan portfolio, assets, liabilities and capital adequacy should be introduced for a full and proper disclosure of the financial situation of the banks, elimination of remaining restrains on interest fixation by the banks should be expedited, alternatives for industrial fiancé should be explored (NBFIs), wider use of on-leading mechanisms through the Grameeen Bank and the NGOs (MFIs) should be a way-out for small for and micro-credit diversification of product base of banks: Venture capital, factoring, asset securitization, leasing and consumer product financing, issuance linked deposit schemes, mutual funds, card business, certificates of deposit, etc, integrated computerized and upgradation of professional skills of officials should be taken up on priority basis, delinking of pay scales of banker from the national pay scale should be expedited and strategic business plans to reduce excess manpower should be undertaken, privatization of banks on ideological ground should be stopped. It must be based on empirical grounds.

The agenda outlined above contain the key elements of a comprehensive action plan, which, if pursued in right earnest, can effectively arrest the deterioration of the trend of mounting bank loan default, we believe. The proposed amendments of existing laws and enactment of new laws will help in achieving the following objectives:

The amendments will increase Bangladesh Bank’s autonomy and power to regulate and supervise (both on-site and off-site) the financial system.
The amendments should be designed to severely restrict insider lending plaguing the private commercial banks.
The amendments should aim at providing exemplary punishments to people issuing had cheques and banks involved in corruption and malpractice’s
They should be designed to improve the governance of NCBs
They should improve the deposit insurance schemes.
The new laws will provide effective mechanism to pursue the willful defaulters. The proposed tribunal should be entrusted to deal with cases of the top 500 defaulters only to speed up the disposal of the recovery cases significantly.


1. The office of the Ombudsman for the Financial Sector
The proposed office of Ombudsman for the financial sector will be responsible only to the Board of Director of Bangladesh Bank. The Ombudsman will be helped by a network of ethics in each bank that will be responsible only to the respective Board of Directors. The office of ombudsman will deal with complaints of malpractices and corruption in the banking sector independently, and will recommend appropriate punishments for the investigated cases.

2. De-politicization of Governance of Banks
A management selection committee should be formed to recommend appointments of members of the boards of different banks.
International auditing and accounting standards should be uniformly followed in all the banks to bring transparency and comparability of accounts of different banks.
Financial control systems should be standardized.
Trade unions should be de-linked from direct political affiliations, and the number of trade unions should be limited to three for each bank.
The post of Governor of Bangladesh Bank should be made constitutional.
The banking division of the Ministry of Finance should be entrusted the role of supervising the NCBs and the specialized banks remaining under government ownership.
The autonomy of Bangladesh Bank should get priority it deserves.

3. Enforcement of laws
The legal system allows defaulters to delay lenders recourse process indefinitely, making the enforcement process a virtual mockery. Therefore, the issue of establishing specialized debt collection agency for pursuing the top 500 defaulters needs special attention.

6.4 Other Remedies
• Banking profitability in the long run depends on a bank’s ability to collect and analyze information and to put optimal conditions to its loan supply. To develop this ability, financial institutions must be in a condition of sound market competition and appropriate prudential regulation.
• Considering credit as scarce resources and source of economic and political power, all the societies around the world are careful about its distribution and use. In order to best utilize credit an attempt should be made in order to avoid concentration of loans into few hands.
• Strengthening the security market will have a positive impact on the overall development of the banking sector by increasing the competitiveness in the financial sector. In a developed capital market the range of portfolio selection in wider and people can compare the security of their investment among the banks and the security market. As a result banks remain under some pressure to improve their financial soundness.
• Bangladesh has a bright prospect in the sectors of small and medium scale enterprises. Poorer sections of the society have innate entrepreneurial ability of undertaking some small profitable projects. Successful operation of some NGOs (Grameen Bank and BRAC are few of them) provides evidences the poor people can be bankable even without collateral.
• Bangladesh may look for and utilize a number of merger and acquisition cases especially among the larger banks if any for the better information sharing, management and diversification of activities.
• In the Bangladesh banking sector, the main conflict is that the loss due to inefficiency of collection of bad loans for whatever reasons. Where the shareholders are definitely not responsible, are adjusted by making provisions out of profit and then utilizing this provision to write off bad loans, the collection of which is uncertain. It may not be justified because the amount and payment system is not linked to performance, especially in case of less than average performance. To minimize this conflict, loan classification should be stopped, that is, regular repayment should the ensured. This will reduce the provision for the loan loss amount, which in turn will result in more tax payment and more after tax profit of the organization, which is the precondition for maximization of shareholders’ wealth. Provision in other business is an estimation based on the past experience of the uncollectible amounts. If banks can stop classification, then 1 percent of unclassified loans will suffice or in the future this percentage may also reduced.

Chapter Seven
Findings and Conclusions

7.1 Issues and Observations

The foregoing discussion regarding NPLs in Bangladesh reveals that the banking sector of Bangladesh is yet to get out of its NPL mess, although substantial improvement has been noticed recently, in terms of adoption of the international loan classification and provisioning system, Bangladesh follows the international standar to a great extent, but lags far behind with regard to the management of NPLs. At present, the banking system of Bangladesh exhibits a very high proportion of NPLs when compared to India and Sri-Lanka. The most dissatisfactory performance is seen in the management of “Bad Loan” which consistently account for more that 80% of total NPLs. This situation clearly demonstrates the inefficacy of the banking system to tackle the “flow problem of bad loans”. Therefore, the first challenge facing the banking sector of Bangladesh is how to constitute sufficient measures to address the flow problem of bad loans effectively.

It is observed that among the different clusters of banks in Bangladesh, NCBs continue to have an alarming amount of NPLs (Table 4.4 and Table 4.5) since the adoption of prudential norms in 1990. Although it is not clear which sectors contain major NPLs, but it is observed that the highest ratio of NPLs are in the category of micro and agricultural loans of NCBs followed by terms loans having a maturity of more than 5 years. The NPL ratio of term loans given by NCBs is observed to be very high (Table 4.5). Another important observation is the gradual reduction of capital in NCBs due to maintenance of poor loan loss provisions against default loans. These aspects clearly call for ending the operation of NCBs. However, it needs to be mentioned there that the stock markets of Bangladesh are not efficient enough to channel funds for industrial growth, and thus NCBs play a vital role in meeting the overall industrial credit needs of the country. Hence the challenge before the banking system is to stop the operations the NCBs, to privatize them, or to reorient them through financial engineering in full phase.

In a bank-centered financial system, it is very crucial to determine whether the defaulter is a willful one or a genuine one. In the case of the former, if timely and adequate measures are not taken and problems are left unresolved, the willful defaulters can have a psychological impact on goods borrowers, acting as a catalyst to financial degradation. In fact, in developing countries like Bangladesh, a large number of willful defaulters operate in the financial market, trying to degrade the credit environment either by window-dressing their financial health or by influencing the bank management through vested groups, or both. In many reports serious concerns have been shown about the presence of willful defaulters in Bangladesh and it has been suggested that loan facilities should not be offered to this group. Nevertheless, in reality, the banking system has not yet come up with any effective strategies to identify the habitual defaulters and to take action against them, In this regard, a crucial challenge before the banking sector could be seen as how to develop specific tools and techniques to distinguish the willful defaulters from the genuine ones.

The study reveals that the dissatisfactory performance of the courts (Money Loan Court, Bankruptcy Court and PDR Court) in terms of rate of settlement of NPL disputes as well as rate of recovery of loans over the years (Table 5.1 and Table 5.2). The main problem related to very low recovery lies in the very slow execution of the decrees. The Financial Sector Reform Project (FSRP) argues that the huge loan delinquency of the Bangladesh banking system reflects, among other things, the weakness of the legal infrastructure, which cannot ensure lenders’ recourse to borrowers. The inefficacy on the part of the legal system also sometimes encourages borrowers to refrain from paying legitimate dues to the banks. The Centre for Policiy Dialogue (CPD) Task Force Report (2001) also indicates that the main hindrance at this moment in Bangladesh is the existing legal framework and its lengthy procedures. However, if the delay in the settlement process arises due to the shortage of judges, then separate posts like “Bank Magistrates” can be created to settle NPL issues. It is to be kept in mind, however, that without having the proper co-operation and sincerity and accountability of the involved parties like plaintiff, defendants, lawyers and judges, in order to make the settlement process vibrant and speedy.

Almost a decade ago, the banking system of Bangladesh adopted a Lending Risk Analysis (LRA) device, a prescribed manual for analyzing loans of Tk.10.00 million and above with the objective of evaluating the intensity of risk associated with large loans and to choose loan proposals with low risk exposures. LRA has now been superseded by the “Credit Risk Grading System” for better identification and management of borrower’s risk. However, the application of this sophisticated technique (CRG) as a credit screening and monitoring tool largely depends on sufficient business data and know-how of the concerned credit officials. Surprisingly, these are seen to be very poor in the credit environment of this country. Thus the appropriate authorities should pay proper attention to redressing these problems to ensure meaningful application of the CRG device in the credit environment of Bangladesh.

The following issues and observations are also found during the completion of the report.

a. We have to keep in mind that our present loan classification criteria are more relaxed than what is followed in the developed countries. Also, a classified loan becomes regular at the time of rescheduling which is not the case in developed country. Therefore, the magnitude of the NPLs problem in Bangladesh is more severe if we take into account the standard norms of classifying loan in developed countries. Bank officials/political parties associated with this issue of willful default. Not much improvement in this area is expected unless there is strong political commitment and we can introduce a system of ‘reward and punishment’ in the banking sector.
b. Loan recovery effort of banks is subject to limitation of their resources. This necessitates the importance of putting emphasis on recovery of big loan. One estimate made in this regard by the end of 1990s showed that top 500 defaulters accounted for 70 per cent of non-performing loans. It was rightly opined by Dr. Wahiduddin Mahmud (2005) in fifth Nurul Matin Memorial Lecture that unless it can be demonstrated very clearly through action that these top defaulters are pursued with success, there would be little incentives for small defaulters to settle their debts.
c. It is obvious that the high non-performing loans ratio forces a bank to charge relatively higher lending rate from the borrowers than that could have been otherwise. So, the ethical norms will be violated if borrowers with good track record are not discriminated in the form of lower interest rate against the bad borrowers. But, do we observe such interest rate variation among the otherwise identical borrowers?
d. It was rightly opined by (Alam and Jahan, 1997) that the collaterals do not have any effective role in the performance of a credit facility. Banks in Bangladesh have enough legally realizable collateral at their disposal to fall back upon; but the reality is that, due to the weak enforcement status of lenders recourse related laws, in many cases banks can not realize their full exposure by selling the mortgaged property. A basic policy shift from collateral based lending to the cash flow based lending is thus required for the improvement of the loan quality.
e. Lack of transparency and inadequate information disclosure were believed as partly responsible for the case of the prolonged crisis in the banking sector. Legal requirement of transparent and adequate information flow make the bank management more accountable to the owners of banks and thus, helps to bring back the market discipline. Improved disclosure promotes market competition as the depositors start to discriminate between the good banks and the bad ones (Mahmud, 2005). However, a delicate balance is required in this regard as over reaction by the depositors may lead to instability in the banking sector.
f. Right from the beginning, the then nationalized commercial banks have played a very significant role in mobilizing deposit through a countrywide network of branches and also by serving the socio-economic purpose under the government directed credit program. But, we have to keep in mind that this process itself creates moral hazard problem and causes inefficiencies to grow. Banking profitability in the long run depends on a banks’ ability to collect and analyze information and to put optimal conditions to their loan supply. To develop this ability, financial institutions must be subjected to market discipline and appropriate prudential regulations. Traditionally, we do not have exit mechanism in the banking industry. So, it is natural that giving a sort of implicit guarantee to the banks will produce some imprudent behavior.
g. It has become our convention that we make unnecessary delay in taking timely action to combat any deep-rooted problem. The on going non-performing loans problem of the banking sector is a classic example of that. A long time has elapsed in recognizing the severity of the problem and also in implementing a revised set of prudential norms, establishing more robust risk management techniques backed by well designed central bank’s supervisory role. Regulatory forbearance has the potentiality of making the situation more vulnerable, which ultimately needs very costly adjustment. State-owned commercial banks and DFIs in Bangladesh have long been characterized with low profitability, low capital base and a very high percentage of non-performing loans. Is it taken for granted that the performance of state owned banks would always remain below that of the private owned banks? If not, then shouldn’t we come forward immediately to bring them in line with others.
h. Real sector and financial sector are mutually interrelated in that the market condition of one affects the other. Bangladesh has consistently achieved a fair growth rate of around 5-6% in the last few years despite facing some bottlenecks in the area of infrastructural facilities and overall political instability. Macroeconomic management can be thought of as supportive to this steady growth rate and we do not observe any such major policy error. The sub-optimal performance of the banking sector, thus, can neither be attributed to the problem in the real sector arising from the demand side nor to the major policy errors; rather it can be safely argued that the full potential of macroeconomic performance could not be achieved in the last few years due to inefficiency in the banking sector.
i. High percentage of non-performing loans in the banks generally causes ‘credit crunch’ or shrinkage in credit flow from the supply side of the bank. It is expected to be so because of more conservatism or cautiousness in approving new loans. Ogawa and Kitasaka (2000), Montgomery (2004) and Siddique (2004) in their study on non-performing loan problem of banking sector found the evidence of credit crunch. Interestingly, the overall credit flow of our financial sector shows a smoothly rising trend even in the backdrop of a large non-performing loan stock although one study found a slump in the supply of industrial credit by the DFIs (Hoque, 2004). Does it indicate that we did not give due emphasis on recovery of loan? Although, no such rigorous studies have been undertaken to show the presence of credit crunch in our context, it also might be inferred that small sector and especially the enterprises with minimum track record are facing difficulty in getting financial assistance from banks.
j. It is useful for policy purpose to regularly assess the lending attitudes of financial institutions. One direct way to assess the degree of credit crunch and to isolate the impact of supply side of loan from the demand side is to take into account the opinion of the firms about banks’ lending attitude which is carried out in some countries by the central bank. Bank of Japan conducts a survey across the enterprises to get the perceptions of economic agents. One of such surveys is focused on the lending attitude of financial institutions as perceived by the responding enterprises. Each respondent is asked to give one opinion out of three alternatives. The available options are 1) Accommodative 2) Not so Severe, and 3) Severe. Finally, a Diffusion Index (DI) is calculated by subtracting the percentage share of enterprises responding choice 3 from the percentage share of enterprises responding choice 1. Can we think of introducing such kind of exercises in Bangladesh by the central bank?
k. Policy responsiveness of the behavior of economic agents is important in any crisis situation. We see noticeable improvements in our banking sector, especially in credit management due to a set of prudential guidelines, more strengthened supervision by the Bangladesh Bank backed by the major revisions of lenders recourse related laws. This raises our hope in managing the crucial dimensions of banking activities. So, policy foresightedness, timeliness and dynamic response are essential in improving the performance status of the banks.
l. Finally, strengthening the securities market will have a positive impact on the overall development of the banking sector by increasing the competitiveness in the financial sector. In a developed capital market the range of portfolio selection is wide and people can compare the return and security of their investment among the banks and the securities market operators. As a result banks remain under some pressure to improve their financial soundness. However, developing a strong capital market remains at this stage of our development a very challenging task.

7.2 Conclusion
Our banking sector is characterized by low profitability and inadequate capital base. The crux of the problem lies in the accumulation of high percentage of non-performing loans over a long period of time. The problem is most severe for NCBs and DFIs. However, starting from a very high rate of 41.1% in 1999 it came down gradually to 10.80% in 2008 according to latest published data. Still, it is very high by any standard. Unless it can be lowered substantially we will lose competitive edge in the wave of globalization of the banking service that is taking place throughout the world. We have had a two-decade long experience in dealing with the NPLs problem and much is known about the causes and remedies of the problem. Unfortunately, the banking system is still burdened with an alarming amount of NPLs and lags far behind the neighboring countries of India and Sri Lanka. Although Bangladesh has to a large degree adopted international standards of loan classification and provisioning, the management of NPLs is found ineffective, as the system has failed to arrest fresh NPLs significantly. It needs to be mentioned that management of NPLs must be multi-pronged, with different strategies pursued at the different stages through which a credit facility passes. Measures should be in place for both prevention and resolution. With regard to preventive measures, emphasis needs to be placed on credit screening, loan surveillance and loan review functionaries both at individual bank levels and in the central bank of the country. Resolution measures must be accompanied by legal measures, i.e. improving the efficiency of the legal and the judicial system and developing other out of the court settlement measures like compromise settlement schemes, incentive packaging, formation of asset management companies, factoring, asset securitisation and so on. Unfortunately, Bangladesh is found to be very weak from the above point of view, and strictly speaking, it has mainly concentrated on a few legal measures that have also been found to be ineffective. Therefore, this study has highlighted some challenges, shown below, for improving the debt recovery environment and solving the NPL problems of the country as well.

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