Non-performing Loans in Banking Sector of

Bangladesh Causes and Effect

Submitted to:
Sk. Alamgir Hossain
Lecturer
Dept. of Finance
Jagannath University, Dhaka.

Submitted by:
Md. Abdullah Al Masum
MBA ID. M130203055
Session: 2013-14
Dept. of Finance
Jagannath University, Dhaka.
 Table of Contents

Serial No. Topics Page No.

Letter of transmittal
Acknowledgement
Executive Summary
Chapter 1 Introduction
1.1 Objective of the Study
1.2 Methodology of the Study
1.3 Limitations of the Study
Chapter-2 Literature Review
Chapter 3 Banking industries of Bangladesh
3.1
3.2
3.3 Strategic Objectives
3.4 Ethical Standards
Chapter 4 Definition of NPL
4.1 Classified Loan
4.2 Non Performing Loan in BD
4.2.1 Base for Provisioning and accounting treatment of NPLs
4.2.2 Trend of Loan Default Problem in Bangladesh
4.2.3 The Present status of Loan Defaults Culture in Bangladesh
4.2.4 Present Status of Non-performing Loans
4.3 Causes Of Non Performing Loans
Chapter 5 Analytical Part
5.1 Descriptive Analysis
5.2 Multiple Regression Analysis
Chapter 6 Findings, Recommendation & Conclusion
6.1 Findings
6.2 Recommendation
6.3 Conclusion
Appendix

List of tables
Name of Tables Page no.
Table-1 Banking industries of Bangladesh
Table-2 Contribution of Banking sector in National Import
Table-3 National and Agrani Bank Limiteds Export Performance
Table-4 Country wise remittance of Banking sector
Table-5 Data Analysis
Table-6 Income from Export, Import and Remittance comparison with Net
Income
Table-7 Amount of Export, Import, Remittance and Net Income
 Letter of Submission

3rd Septeber, 2015

To
SK. Alamgir Hossain
Lecturer
Department of Finance
Jagannath University, Dhaka.

Subject: Submission of internship report.

Dear Sir,

It is my great pleasure to submit the report on NPLS in Banking Industry of Bangladesh: Causes
and Effects that you have assigned me.
It has been a great experience for me to prepare a report. I tried my level best to put meticulous
efforts for the preparation of this report. Any shortcomings or flaw may arise as I am novice in this
aspect.
I have tried to make each and every element relevant to my topic and discussed under the context
of whatever I have learned from the course. It would be pleasure for me, if this report can serve its
purposes.

Thanks and Regards

Yours Faithfully

...
Md. Abdullah Al Masum
MBA Program (4th Batch)
Roll No. M130203055,
Reg. No. 1001335292
Department of Finance
Jagannath University, Dhaka
 Supervisors Certification

This is to certify that Md. Abdullah Al Masum is a student of MBA (Finance), Jagannath
University bearing ID No: M130203055. He has completed his Internship Report entitled NPLS
in Banking Industry of Bangladesh: Causes and Effects. He has completed the Internship
report under my supervision for the partial fulfilment of the award of MBA (Finance) degree.

As far as I know he tried his best to conduct this report successfully. I think this study will help him
in the future to build up his career.

I wish his every success in life.

With best wishes & regards

....

SK. Alamgir Hossain

Lecturer,
Department of Finance
Jagannath University, Dhaka
 Declaration
I affirmed that the Internship report titled Non-performing Loans in Banking Sector in
Bangladesh being submitted for the internship part of MBA program is the original work carried
out by me. I further declare that this Internship report is based on my original work and no part of
this project has been published or submitted to anybody.

Thanks and Regards

Yours Faithfully

............

Md. Abdullah Al Masum

MBA Program (4th Batch)
Roll No. M130203055
Reg. No. 1001335292
Department of Finance
Jagannath University Dhaka
 Acknowledgement

The report on Nonperforming Loans in Banking Sector of Bangladesh: Causes and Effects has
been prepared to fulfill the requirements of MBA degree. I am very much fortunate that I have
received sincere guidance, supervision and co-operation from various respected people while
preparing this report.
At the very beginning I would like to express my gratitude to God for special blessing in
completing the report. Then, I would like to thank my academic supervisor of the Internship
Program SK. Alamgir Hossain, Lecturer,Department of Finance ,Jagannath University, Dhaka for
giving me the opportunity to prepare this report. He also provided me some important advices and
guidance for preparing this report. Without his assistance, this report would not be a comprehensive
one.

Md. Abdullah Al Masum

MBA Program (4th Batch)
Roll No. M130203055
Reg. No. 1001335292
Department of Finance
Jagannath University Dhaka
 Abbreviation

AD = Authorized Dealer
BLC = Bills under letter of Credit
CC = Cash Credit
DPS = Deposit Pension Scheme
ERC = Export Registration Certificate
FDD = Foreign Demand Draft
L/C = Letter of Credit
LTR = Loan against Trust Receipt
PF = Provident Fund
HBL = House Building Loan
OD = Overdraft
DL = Demand Loan
CLS = Consumer Loan Scheme
 Executive Summary
Nonperforming loans is common phenomena for banking industry in Bangladesh. A Non-
performing loan is a loan that is in default or close to being in default. Many loans become non-
performing after being in default for 90 days, but this can depend on the contract terms. NPLs
started at the early stage of liberation. During 1980s and 1990s, Privatization and liberalization of
banking sector could not control NPLs. Rate of NPLs was 41.1% in 1999. Now it is 11.90%.The
amount of NPLs increased to taka 73.3 billion in 2012 from taka 47.3 billion in 2003.There are
many reasons behind the NPLs in Bangladesh. First reason is entrepreneurs related. Borrower may
be have lack of experience, lack of business and lack of institutional training background or lack of
supporting facility. Sometime borrowers do it intentionally. Entrepreneurs age also an important
factor. Second reason is business related. Sometime banks give loan to businesses which are not
attractive. Strong competition is another business related cause. Borrower becomes defaulter if
there is poor management capability, poor financial performance, and poor cash flow. Business
could be defaulter because of low market share. Low market share mean low revenue so that
business cannot pay the interest payment. Third reason is leading related. It is mainly Banks fault.
Loan could be default if Bank delayed assessment of loan proposal, delayed disbursement of fund,
lack of proper monitoring, lack of taking proper action. Last reason is macroeconomic factors. Low
GDP growth, increasing crimes, hartals and frequent policy change effect loan. For those reasons
loans become default loan. Effects of NPL are such as Stopping Money Cycling, Earning
Reduction, Capital Erosion, Increase in Loan Pricing, Frustration etc. As a result, the values of
security are increased and the risks of financial recession also see a rise.
Chapter -1
Introduction

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).

It is obvious that NPLs reduce banks profitability, as banks cannot appropriate interest income
from their classified loans. NPLs reduce loan able 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 if there is no provision (assume). 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 ratio of NPL to total loans of all the banks had shown an overall declining trend from its
peak 34.9% percent to 10 percent in December 2012.The ratio further increased to 11.9 percent
at the end of June 2013.

1.1. Objective of the Study

The objectives of this paper are
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.
1.2. Meth od ology of Study:
The research methodology of the study has been enumerated below:
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, Bangladesh Bank Credit Risk Grading
manual , Bangladesh Bank annual report etc.

1.3. Limitations of the study:

The limitations of the study are
1. This study did not cover primary and unpublished data.
2. The major problem faced while conducting the research was unavailability of relevant data.
3. Time constraint.
Chapter 2
Literature Review:
Non-performing loans refer to those financial assets from which banks no longer receive interest or
installment payments as scheduled. It is a very critical but frequent issue in bank fund management and the
present situation of NPLs in Bangladesh is a topic of great concern. It can bring down investors
confidence and 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 volume of default loans of
state owned commercial banks in Bangladesh (BD) has been increasing at an alarming rate. It is not a new
issue but the tendency of fraud, embezzlement and loan default is in a serious situation in recent years due
to excessive political interference and illegal interruption of the concerns. The amount of total NPLs in the
banking system of BD was Tk 523.1 billion at the mid of 2014, which was Tk 427.3 billion in 2013 and 200.1
billion in 2007. The amount doubled within 8 years. For last 8 years, loan default as a percentage of
outstanding loans in state owned commercial banks was 50% or above where Private commercial banks and
foreign commercial banks and hold maximum 5-10 % amount of the total. If the scam series continues
then it may put the entire banking sector in an embarrassing situation with the increase of Non-Performing
loan in an alarming rate. Bangladesh Bank has given ultimatum to 11 local and foreign banks to bring down
their soaring non-performing loans to below 10 per cent of their respective outstanding loans .

Lending decision of a bank is very important because it determine the future profitability and performance of
the bank. Recently banks are becoming more and more conscious in customer selection to avoid the
negative impact of bad loan or non-performing loan. The issue of nonperforming loans (NPLs) has gained
increasing attentions in the last few decades. Amounts of bad loans are alarmingly increasing in not only the
developing and under developed countries but also in developed countries. Banks lending policy could have
crucial influence on non-performing loans. A default is not entirely an irrational decision. Rather a defaulter
takes into account probabilistic assessment of various costs and benefits of his decision. Lazy banking
critically reflects on banks investment portfolio and lending policy (Reddy & Mohan (2003); Sinkey
(1991) & Dash (2010) sector. According to the definition of the Financial Reconstruction Law (FRL), the
total amount of NPLs of all banks in Japan as of the end of March 2003 was 35.3 trillion yen, although there
are claims that the actual amount of NPLs might exceed 100 trillion yen. On the other hand, the causes of the
financial and exchange rate crisis that erupted in East Asia (Thailand, Taiwan, Malaysia and Indonesia) in
1997 are viewed as high short-term external debts, excessive loans for real estate, large current account
deposits, high international interest rates and weaknesses in the balance sheet of financial institutions. In
addition, Kwack (2000: 195-206) finds that the 3-month LIBOR interest rate and nonperforming loan rates
of banks were the major determinants of the Asian financial crisis. Huang and Yang (1998: 11) report that
unlike the other countries of East Asia, China did not face financial fragility because of the size of its foreign
exchange reserve, its current account surplus, the dominance of foreign direct investment in capital flows and
the control of the capital account. As of June 2003, China recorded only 5.68% of its total loans as
nonperforming while, in contrast, Thailand, Indonesia, Philippines and Malaysia record NPLs at 15.29%, 8%,
15% and 8.7% respectively. Unfortunately, the present (December, 2005) rate of NPLs in China has increased
to 8.6%.

In the Indian subcontinent (India, Pakistan, Sri Lanka, Bangladesh and Nepal), however, the causes of
nonperforming loans are usually attributed to the lack of effective monitoring and supervision on the part of
banks (as required by the BASEL principles of bank monitoring and supervisions), lack of effective lenders
recourse, weaknesses of legal infrastructure, and lack of effective debt recovery strategies. Among the
countries in the Indian sub-continent, the rate of NPLs as a percentage of total loans disbursed in 2005 is seen
to be minimal in India (5.2%), followed by Sri Lanka (9.6%). Bangladesh, however, still records a staggering
rate of 13.56%.
Chapter -3
3.1 History of Banking Industry in Bangladesh :
After the independence, banking industry in Bangladesh started its journey with 6 Nationalized
commercialized banks, 2 State owned Specialized banks and 3 Foreign Banks. In the 1980s
banking industry achieved significant expansion with the entrance of private banks. Now, banks
in Bangladesh are primarily of two types:

Scheduled Banks: The banks which get license to operate under Bank Company Act, 1991
(Amended in 2003) are termed as Scheduled Banks.State-owned commercial banks, private
commercial banks, Islamic commercial banks, foreign commercial banks and some specialized
banks are Scheduled Banks.

Non-Scheduled Banks: The banks which are established for special and definite objective and
operate under the acts that are enacted for meeting up those objectives, are termed as Non-
Scheduled Banks. These banks cannot perform all functions of scheduled banks. Grameen Bank,
Probashi Kallyan Bank, Karmasangsthan Bank, Progoti Co-operative Land Development Bank
Limited (progoti Bank) and Answer VDP Unnayan Bank are Non-Scheduled Banks.

Non-banking financial institutions which are not banks.These institutions cannot perform all
functions of banks, which get license to operate under Financial Institution Act, 1993 are termed
as Non-banking financial institutions.

3.2 List of commercial Banks

State-owned Commercial Banks

1. Sonali Bank Limited

2. Janata Bank Limited
3. Agrani Bank Limited
4. Rupali Bank Limited
5. BASIC Bank Limited
6. BDBL (Bangladesh Development Bank Limited)
State-owned Specialized Banks

1. Rajsahi Krishi Unnoyon Bank (RKUB)

2. Bangladesh Krishi Bank Limited

Private commercial Bank

Private banks are the highest growth sector due to the dismal performances of government banks
(above). They tend to offer better service and products. Here is the list:

1. AB Bank Limited
2. Bangladesh Commerce Bank Limited
3. Bank Asia Limited
4. BRAC Bank Limited
5. Dhaka Bank Limited
6. Dutch Bangla Bank Limited
7. Eastern Bank Limited
8. IFIC Bank Limited
9. Jamuna Bank Limited
10.Meghna Bank Limited
11.Mercantile Bank Limited
12.Midland Bank Limited
13.Modhumoti Bank Limited
14.Mutual Trust Bank Limited
15.National Bank Limited
16.NCC Bank Limited
17.NRB Bank Limited
18.NRB Commercial Bank Limited
19.NRB Global Bank Limited
20.One Bank Limited
21.Prime Bank Limited
22.Pubali Bank Limited
23.Simanto Bank Limited (proposed)
24.South Bangla Agriculture and Commerce Bank Limited (www.sbacbank.com)
 25.Southeast Bank Limited
26.Standard Bank Limited
27.The City Bank Limited
28.The Farmers Bank Limited
29.The Premier Bank Limited
30.Trust Bank Limited
31.United Commercial Bank Limited
32.Uttara Bank Limited

There are eight private Islamic Commercial Banks in Bangladesh:

1. Islami Bank Bangladesh Limited

2. Al-Arafah Islami Bank Limited
3. Export Import Bank of Bangladesh Limited
4. Social Islami Bank Limited
5. Shahjalal islami Bank Limited
6. First Security Islami Bank Limited
7. Union Bank Limited
8. ICB Islamic Bank Limited

Foreign Commercial Banks

There are nine foreign commercial banks currently operating in Bangladesh. These are:

1. Bank Al-Falah
2. Citibank NA
3. Commercial Bank of Ceylon
4. Habib Bank Limited
5. HSBC (The Hong Kong and Shanghai Banking Corporation Ltd.)
6. National Bank of Pakistan
7. Standard Chartered Bank
8. State Bank of India
9. Woori Bank

Specialized Banks
Specialized banks were established for specific objectives like agricultural or industrial
development. These banks are also fully or majorly owned by the Government of Bangladesh.

1. Bangladesh Development Bank Limited

2. Bangladesh Krishi Bank
3. Rajshahi Krishi Unnayan Bank
4. Karmasangsthan Bank
5. Probashi Kallyan Bank
6. Palli Sanchay Bank
7. Grameen Bank
8. Ansar-VDP Unnayan Bank
9. Bangladesh Samabaya Bank Ltd
10.The Dhaka Mercantile co-operative Bank Ltd
11.Progoti Co-operative Land Development Bank Limited (Progoti Bank)

NPSB member Banks

1. AB Bank Limited
2. Al-Arafah Islami Bank Limited
3. Bangladesh Krishibank
4. Bank Asia Limited
5. BASIC Bank Limited
6. BRAC Bank Limited
7. Dutch-Bangla Bank Limited
8. Eastern Bank Limited
9. EXIM Bank Limited
10. First Security Islami Bank Limited
11. ICB Islamic Bank Limited
12. IFIC Bank Limited
13. Islami Bank Bangladesh Limited
14. Jamuna Bank Limited
15. Meghna Bank Llimited
16. Mercantile Bank Limited
17. Midland Bank Limited
18. Modhumoti Bank Limited
19. Mutual Trust Bank Limited
20. National Bank Limited
 21. NRB Bank Limited
22. NRB Commercial Bank Ltd
23. NRB Global Bank Limited
24. One Bank Limited
25. Prime Bank Limited
26. Pubali Bank Limited
27. SBAC Bank Limited
28. Shahjalal Islami Bank Limited
29. Social Islami Bank Limited
30. Sonali Bank Limited

31. Southeast Bank Limited

32. Standard Bank Limited
33. Standard Chartered Bank Limited
34. The City Bank Limited
35. Trust Bank Limited
36. Union Bank Limited
37. United Commercial Bank Limited
38. Uttara Bank Limited
39. Agrani Bank Limited
40. Habib Bank Limited

Non-banking financial Institutions

1. Investment Corporation of Bangladesh (ICB)

2. Uttara Finance and Investments Limited
3. United Leasing Company Limited
4. Union Capital Limited
5. The UAE-Bangladesh Investment Company Limited
6. Saudi-Bangladesh Industrial & Agricultural Investment Company Limited (SABINCO)
7. Reliance Finance Limited
8. Prime Finance & Investment Limited
9. Premier Leasing & Finance Limited
10.Phoenix Finance and Investments Limited
11.People's Leasing and Financial Services Limited
12.National Housing Finance and Investments Limited
13.National Finance Limited
 14.MIDAS Financing Limited
15.LankaBangla Finance Limited
16.Islamic Finance and Investment Limited
17.International Leasing and Financial Services Limited
18.Infrastructure Development Company Limited (IDCOL)
19.Industrial Promotion and Development Company of BangladeshLimited (IPDC)
20.Industrial and Infrastructure Development Finance Company (IIDFC) Limited
21.IDLC Finance Limited
22.SUMON Bank
23.Hajj Finance Company Limited
24.GSP Finance Company (Bangladesh) Limited (GSPB)

25.Firt Lease Finance & Investment Limited

26.FAS Finance & Investment Limited
27.Fareast Finance & Investment Limited
28.Delta Brac Housing Finance Corporation Limited (DBH)
29.Bay Leasing & Investment Limited
30.Bangladesh Industrial Finance Company Limited (BIFC)
31.Bangladesh Finance & Investment Company Limited
32.Agrani SME Finance Company Limited
33.CAPM Venture Capital and Finance Limited
34.Meridian Finance and Investment Limited
35.Realistic Finance Bank Limited

Chapter -4
4.1Definition of Nonperforming Loans (NPLs):
A Non-performing loan is a loan that is in default or close to being in default. Many loans
become non-performing after being in default for 90 days, but this can depend on the contract
terms.
According to IMF, definition of NPLs
is
A loan is nonperforming when payments of interest and principal are past due by 90 days or
more, or at least 90 days of interest payments have been capitalized, refinanced or delayed by
agreement, or payments are less than 90 days overdue, but there are other good reasons to doubt
that payments will be made in full (Wikipedia, definition of NPLs).By bank regulatory
definition non-performing loans consist of:
Loans that are 90 days or more past due and still accruing interest, and
Loans which have been placed on nonaccrual (i.e., loans for which interest is no longer
accrued and posted to the income statement).

Loan may also be non- performing if it is used in a different way than that for which it has
been taken. As per Section 5 (cc) of Bank Company Act 1991, 'defaulting debtor' means any
person or institution served with advance, loan granted in favor of him or an institution
involving interest or any portion thereof, or any interest which has been overdue for six
months in accordance with the definition of Bangladesh Bank. Non-performing loans are also
called non-performing assets (NPA), which are loans, classified by a bank or a financial
institute, at the instruction of the regulatory authority, on which repayments or interest
payments are not being made on scheduled time. A loan is an asset for a bank as the interest
payments and the repayment of the principal create a stream of cash inflows. Interest cash
inflow is excess money over principal .Banks usually treat assets as non-performing, if they
are not serviced in scheduled time. If payments are late for a short time, a loan is classified as
past due. Once a payment becomes late (usually 60 days), the loan is classified as non-
performing.
NPL is a sum either of the borrowed money upon which the debtor has not made his/her
scheduled payments, which is in default or close to being in default. Once a loan is non-
performing, the odds that it will be repaid in full are considered to be substantially lower. If
the debtor starts making payments against a non-performing loan, it becomes a performing
loan.

C la s s i f i ed L oa
n:

A classified loan is the term used for any loan that a bank examiner has deemed to be in
danger of defaulting. The borrower does not necessarily need to miss payments order for a
bank to label the account in this manner. A borrower can have what the bank calls a
classified loan for different reasons. This is simply a precaution that financial institutions
take to prepare for a possible loss and to prevent any further risk.
The Bangladesh Bank defines an 8-tier loan classifying system such as Superior, Good,
Acceptable, Marginal, Special Mention, Sub-standard (SS), Doubtful (DF) and Bad/ Loss
(BL). This is actually the key risk grading system in order to measure the assets' quality. This
grading must be used to check asset-quality periodically. Downgrading of any facility should
be informed in Early Alert Reporting (EAR) for decision-making authorities.
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 unfavorable 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.
4.2 Nonperforming Loan in Bangladesh:
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 governments
expansion of credit policies on the one hand and a feeble and in firm banking infrastructure
combined with an unskilled work force on the other. 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. 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. 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 alignments 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 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.
4.2.1. Base for provisioning and accounting treatment of NPLs:
A balance sheet item representing funds set aside by a company to pay for losses that are
anticipated to occur in the future. The actual losses for the earmarked funds have not yet
occurred, but the general provisions account is counted as an asset on the balance sheet.

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.(Marge with provision) .

4.2.2 Trend of the Loan Default Problem in Bangladesh

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.
Post liberation period

After the liberation of Bangladesh, the Awami League Governments 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 todays 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 favors rationed out to those fortunate loaners.

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 lenders
recourse on borrowers almost a mockery in Bangladesh. Therefore, we surmise that behind all
these malaises, the nature of the state 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 Bangladeshs 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 brunt of this ill-advisedly too rapid pace of liberalization of Bangladeshs
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.
4.2.3. 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 governments 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 very frequent and fashionable style of loan defaulting story in banking sector of Bangladesh
is loan scam. Recently a series of scams has started threatening the banking sector in a great way.
Last year, Sonali Bank loan scam started the episode and is continuing with Bismillah loan scam,
Basic Bank loan scam and so on in a large scale. The story of all episodes is almost same and
follows a cycle.

According to Anti-Corruption Commission, 41 reputed commercial banks in Bangladesh were

involved actively in Sonali bank scam of Tk.3665 crore with Hallmark(The Financial Express).
Over 100 branches of seven state-run banks, 29 private banks and five foreign banks patronized
that loan scam according to them.

In 2009, Bangladesh Shilpa Bank and Bangladesh Shilpa Rin Sangsta were merged due to huge
amount of NPL in both of them. The operational activities of BSRS came to a halt, when its
classified loans reached up to 85 to 90 percent of its total portfolio. The situation was almost
same for BSB although it tried to expand its deposit collection on its own rather than
rescheduling the previous non performing loans. It had about Tk 250 crore classified loans on
the eve of being merged, according to media reports.
Defaulted Loan between September 31, 2014 to March 31, 2015
(in crore)
Bank Name Defaulted Loan as of Defaulted Loan as of Dec Defaulted Loan as of
Sept 31, 2014 31, 2014 March 31, 2015
SONALI 11,570.21 9629.29 10,432.43
AGRANI 4387.17 2605.26 3343.48
RUPALI 5118.36 3317.84 332354
BASIC 1697.45 1053.0 1588.57
BDBL 1883.27 1282.36 2557.54
AB 716.04 520.38 616.32
BANK ASIA 596.18 440.48 463..61
BRAC 899.01 580.92 979.90
DHAKA 783.85 750.70 840.23
DBBL 755.23 375.24 563.14
EBL 474.33 402.04 477.06
EXIM 597.96 369.82 427.55
FIRST SECURITY 1003.29 516.82 677.02
ICB ISLAMIC 218.46 248.38 248.63
IBBL 749.28 717.59 725.88
JUMUNA 2788.33 1364.29 2065.99
ONE 331.40 173.10 281.45
MUTUAL TRUST 605.28 448.96 558.08
NATIONAL 698.90 465.98 534.74
4.2.4. Present Status of Non-performing Loans:

The most important indicator intended to identify the asset quality in the loan portfolio is the
ratio of gross non-performing loans (NPLs) to total loans. In 2012 Foreign Commercial
Banks(FCBs) have the lowest and State owned Development Financial Institutions (DFIs) have
the highest ratio of gross NPLs to total loans. State owned commercial banks (SCBs) had a gross
NPLs to total loans of 23.9 percent, whereas Private Commercial Banks (PCBs), FCBs , and
DFIs, had ratios of 4.6,3.5 and 26.8 percent respectively at the end of December 2012.

NPL ratios By( % ) of Banks

Bank 2007 2008 2009 2010 2011 2012 2013 2014 End
types June
2013
SCBs 21.4 22.9 29.9 25.4 21.4 15.7 11.3 23.9 26.4
DFIs 34.9 33.7 28.6 25.5 25.9 24.2 24.6 26.8 26.2
PCBs 5.6 5.5 5.0 4.4 3.9 3.2 2.9 4.6 6.6
FCBs 1.3 0.8 1.4 1.9 2.3 3.0 3.0 3.5 4.7
Total 13.6 13.2 13.2 10.8 9.2 7.3 6.1 10.0 11.9

The gross NPLs ratios to total loans for the SCBs, PCBs, FCBs and DFIs were recorded as 26.4,
6.6, 4.7 and 26.2 percent respectively at the end of June 2015. The ratio of NPLs of all the banks
had shown an overall declining trend from its peak (34.9 percent) I 2000 up to 2011 before it
increased to 10.0 percent in December 2014.
The amount of NPLs of the SCBs increased from taka 105.7 billion in 2003 to
taka 215.1 billion in 2014. The PCBs recorded a total increase of taka 81.8
billion in their NPL accounts, which stood at taka 130.3billion in 2014 as
against taka 48.5 billion in2003. The amount of NPLs of the DFIs increased to
taka 73.3billion in 2014 from taka 47.3 billion in 2003.

Sonali Bank has the Highest default loan (10,432.43 cores) and HSBC has the
lowest default loan(128.06 cores) among the banks at the end of March 2015. In
September 2015, Sonali Bank had the highest default loan (12570.21 cores) and
HSBC had the lowest default loan (109.05 cores).

4.3 Causes of Nonperforming Loans

A. ENTREPRENEURS RELATED

A1: 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.

A2: 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.

A3: 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.

A4: Lack of Supporting Facilities

Sometimes business need support from other sources like government authority. 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.
B: BUSINESS RELATED

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, companys 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. For example: suppose in Bangladesh Jute industry is one of
the non attractive industries. Now any investor want to invest in this sector may be cause loss.
So this investor cant pay the interest.

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 quit 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 on 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. 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. But operating in niche product in a market which is not proper or have fewer customers
that it expected then it cannot be profitable. So it cannot pay its interest payment.

C: LENDING RELATED

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 for financial institutions. 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. before diverse loan, Banks
can check the credit rating of the organization. Banks can generate information about borrowers
from Bangladesh Bank. Then banks can decide how much money investor needs and how much
money he will be invested. Valuation culture of the security or collateral is absent in many of
banks.

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
D: MACROECONOMIC FACTORS

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. For example: in
this budget government increase tax on mobile phones which are imported from foreign country,
so mobile phone importer may not generate expected revenue. So importer could not par their
interest payment. So they could be defaulter. 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.
Name of firm Approved Types of Loan Year of Expiry Reason
Loan Disbursement

It is a trading firm. It imports

Samam Trade 01 Crore Term Loan for 2011 2014 Locker from
china through issuing L/C. From
International 3 years Oct13-
Jan14 the firm didnt open any L/C,
due
to political unrest. It happened
because the
firm had enough stock in its
warehouse,
but due to strike it could not sell its
goods,
as a result the firm got stuck in fund
shortage. On the contrary, the firm
has a
limit of fund for importing goods.
Due to
nonpayment of loan that created
problem
against Import process, the
outstanding of
the loans were getting higher. At the
end
of November13 the client listed as
SMA,
And In March14 the loan declared
Bad
Loan
.
Causes :
1. Hartals by the Political Parties:
Due to strike, firm did not perform
according their plan. So they can not
generate enough revenue to pay the
interest payment.

2. Poor Financial Performance:

lack of proper strategy for strike. So
It cannot generate revenue.
 The client is a local supplier of rod,
Swadesh Steel 50 Lac OD loan 2013 2014 angel
 bar etc. It approached the loan to allow
revolving a
OD limit of 80 Lac. The bank approved
50
Lac for extension of its operation. But
the
proprietors intention was mischievous.
Instead of investing the fund into
business
the owner purchased Land in Savar.
Just
after 3 month of disbursement the
clients
transaction became irregular. The bank
tried to make the client pay the out
standings. But the clients business was
not capable of to pay the proceeds on
regular basis. After 1 year the Loan
became Bad Loan. The Bank is trying
to
recover the amount.
Cause:
1. Lack of Proper Monitoring:
Bank should take information about
the client before approve loan.
2. Unwillingness to Pay:
The client intension was not good.
May be bank kept low collateral so
that he thought that it will not harm
him a lot.
3. Mis use of fund: Client use the
fund to buy the land rather than
invest in business. He may thought
that it will be more profitable than
business.

Chapter -5(Analytical part )

5.1Descriptive analysis
Some research regarding identification, measurement, causes and effect analysis of NPLs has been done by
scholars of our country in different times both issues within country as well as cross boarder comparison.
Nonperforming loans in the banking sector of BD, realities and challenges of NPLs in BD, Impact of
supervisions in controlling NPLs are some frequent topics of articles published in reputed journals in
our country in recent years. SCBs in our country holds major proportion of total deposit of the hole industry
but it is very unfortunate to see the regular default of loan recovery and scams by them in recent times. So to
realize the impact of this evil practice on their performance is a need of time. This paper focuses some
factors directly or indirectly affects their performance that may quest the thrust to some extent.

Figure 1: Capial to risk weighted asset ratio %

30
25
20
15
SCBs
10
5 PCBs
FCBs
0 2007 2008 2009 2010 2011 2012 2013 2014
SCBs 1.1 7.9 6.9 9 8.9 11.7 8.1 1.2
PCBs 9.8 10.6 11.4 12.1 10.1 11.5 11.4 11.4
FCBs 22.7 22.7 24 28.1 15.6 21 20.6 20.3

Source: Banking Performance Indicators, Appendix-3 (Table II), Banking regulation & Policy Department,
Bangladesh Bank, (2005-2013)

Non Performing Loan Rate is the most important issue for banks to survive. There are lots of factors
responsible for this ratio. Some of them belong to firm level issues and some are from macroeconomic
measures. Capital to risk weighted assets of SCBs for the selected 8 years is very much dissatisfactory. In
FY 2007 it was 1.1 % that was really alarming but gradually they started to recover it and in FY 2011 it
reached up to 8.9% which reaches up to 11.7 % in 2011 that is the highest among all the years. But in 2013
it decreases to 8.1 % and drastically fell in 2014 by touching only 1.2%. If we make a comparison the
ratio of SCBs with PCBs and FCBs then we easily have a clear idea about the competitive scenario. The
lowest value of PCBs and FCBs are
9.1 % and 15.60% respectively where the highest value of SCBs is below than 9%.

Figure 2: NPLs to Total Loans ratio %

30
25
20
15
SCBs
10
5 PCBs
FCBs
0 2009 2008 2009 2010 2011 2012 2013 2014
SCBs 22.9 29.9 25.4 21.4 15.7 11.3 23.9 26.4
PCBs 5.5 5 4.4 3.9 3.2 2.9 4.6 6.6
FCBs 0.8 1.4 1.9 2.3 3 3 3.5 4.7

Source: Banking Performance Indicators, Appendix-3 (Table III), Banking regulation & Policy
Department, Bangladesh Bank, (2006-2014)
NPL is a general factor for banking as it is acceptable up to a certain limit. How much loans are being
non- performing each year is a relevant measurement in this regard. NPLs to total loans ratio for SCBs
for selected 8 years is really alarming as most of the years it holds more than 20% NPLs as per Total Loans
and Advances. In 2011 there was a breakthrough in NPL ratio in SCBs as it shows a negative growth rate
of -0.27% and the ratio was 15.70 that was a positive sign but it could not keep it up rather it touches 26.4
% in 2014 that is surely alarming. (See Figure 2) If we make a comparison among three categories of
banks we find that PCBs has maximum NPLs in 2014 and the ratio was 6.6 % and in maximum years they
are maintaining a limit within 5%.Again, FCBs are performing with a great excellence in this topic by
maintaining the limit of NPLs ratio within 3% in every selected years.

Figure 3: Comparative position of NPLs

600

500

400

300

200

100
2009 2008 2009 2010 2011 2012 2013 2014
Total NPLs (in 200.1 226.2 224.8 224.8 227.1 226.4 427.3 523.1
NPLs
billion)in SCBs 115 137.9 127.6 121.6 107.6 91.7 215.1 261.55

Source: Banking Performance Indicators, Appendix-3 Banking regulation & Policy Department,
Bangladesh Bank, (2007-2014)
From the above graph it has been found that SCBs hold the maximum portion of the total NPLs in banking
industry over the selected years from 2007 to 2014. Among them in 2015 the industry tested the largest
amount of NPLs that was tk. 523.1 billion dollar. There exists a consistent harmony in NPLs amount which
depicts that there is very poor initiative in controlling and recovery process of those banks. The graphical
presentation given below (figure 4) is showing the percentage of NPLs hold by SCBs of the total amount.
Here, it is found that each of the years holds more than 50% of total NPLs except in FY- 2011 and FY-
2012. So, there is a red light to the SCBs to reduce the amount of problem lending as early as possible.

30
25
20
15
10
5 SCBs
0
-5 PCBs
-10 FCBs
-15 2007 2008 2009 2010 2011 2012 2013 2014
SCBs 0 0 22.5 26.2 18.4 19.7 -11.9 11.7
PCBs 15.2 16.7 16.4 21 20.9 15.7 10.2 5.5
FCBs 21.5 20.4 17.8 22.4 17 16.6 17.3 19.7

Source: Banking Performance Indicators, Appendix-3 (Table IX), Banking regulation & Policy
Department, Bangladesh Bank, (2007-2014)
 The graph can be a great source to understand how much poor the profitability trend of SCBs in our
country. In 2007 and 2008 ROE for SCBs was just 0. But this horrible situation has been changed
drastically in 2009 when the ratio touched 22.5% and the next 26.2%. In 2011 it decreased but the
percentage is tolerable. The growth rate of ROE was also so poor and in a declining mode up to 2013
also with a negative value in 2013. If we try to draw a comparative idea then find PCBs maintained at least
15% ROE in last 8 years except 2013 and 2014 with huge fall. But FCBs show a great performance as it
maintains at least 17% ROE in every year.

Based on the review of the literature it has been clear that there is extensive national as well as
international evidence which suggests that NPLs can be explained by both macroeconomic and bank
specific factors. But there are some qualitative variables that have significant effect on increasing NPLs that
can be included in a model to find out the effect. Moreover NPLs have serious negative impact on
loan growth rate. So there should have a impact of NPLs on banks profitability as it reduces loan amount
and interest income of the banks simultaneously.
5.2Multiple Regression analysis :
In order to investigate the impact, the following four research hypothesis have been developed-

H0 (1): There is no significant impact of Non Performing Loan Ratio on profitability (Net Interest
Income) of SCBs for last 8 years.

H1 (1): There is significant impact of Non Performing Loan Ratio on profitability of SCBs for last 8 years.

H0 (2): The impact of Deposit Growth Rate on SCBs profitability (NII) is statistically insignificant for last 8
years.

H1 (2): There is significant impact of Deposit Growth Rate on SCBs profitability (NII) for last 8 years.

H0 (3): The impact of Growth Rate of NPLs on SCBs profitability (NII) is statistically insignificant for last 8
years.

H1 (3): There is significant impact of Growth Rate of NPLs on SCBs profitability (NII)

H0 (4): The impact of Provision Growth Rate on SCBs profitability (NII) is statistically insignificant for
last 8 years.

H1 (4): There is significant impact of Provision Growth Rate on SCBs profitability (NII) for last 8 years.

In this paper, I have selected 4 state owned commercial banks in Bangladesh and collected data based on
some factors affect banks profitability as well as performance. NPL is one of the major factors of the
analysis. A model has been established to find out the significance of impact of those factors on
performance of the SCBs like the model used by Yixin Hou (2006) to find out the effect of NPLS on loan
growth rate of commercial banks. The model developed is as follows:

Y= + 1X1 - 2 X2- 3 X3+ 4 X4+ 5 X5+ 6 X6+i

Where,
Y= Net Interest Income (NII)
= Intercept Coefficient

X1= NPLs Ratio (NPLR)

X2= Deposit Growth Rate (DPGR)
X3= NPLs Growth Rate (NPLG)
X4= Provision Growth Rate of (PRVG)
i = Slope Coefficient,
i =Error Term

The data used in this linear regression model is time series data as the values used here is collected
from same sources at a fixed interval of time for FY-2006 to FY-2014. Excess ratio of NPLs to total
loans is harmful for a bank as it negatively affects the lending behaviour by decreasing interest income and
loan growth rate. This paper is mainly focused on how much negative effect NPLs have on NII of SCBs
in Bangladesh.

b
Table : 1 Model Summary

Std. Error of
Model R R Square Adjusted R Square the Estimate Durbin-Watson
1 a .959 .904 3.21333 2.310
.979
a. Predictors: (Constant), PRVR, NPLR, NPLG, DPG
b. Dependent Variable: NIIR

Table-1 represent that the coefficient of correlation of the model R is 0.979that states there is strong
relationship between dependent and independent variables used in this model. Coefficient of determination
2
R 0.959 that shows the highest percentage value that the independent variables explain 96 percent change
2
of NII. The goodness of fit test of the model is also excellent as the adjusted R is 0.904. The value of
Durbin Watson is 2.310 that lie within the range between 1.5 and 2.5. so we can easily state that there is
no autocorrelation among the independent variables of the study.
 a
Table : 2 Coefficients
Standardize
Unstandardized Coefficients d Collinearity Statistics

Model B Std. Error Beta t Sig. Tolerance VIF

1 (Constant) 73.178 8.925 8.200 .004

NPLR -1.880 .242 -1.087 -7.777 .004 .701 1.427

DPG -.899 .295 -.481 -3.050 .055 .549 1.820

NPLG .091 .072 .195 1.257 .298 .569 1.758

PRVG -.074 .029 -.354 -2.568 .083 .719 1.391

a. Dependent Variable: NIIR

From table-2 it is found that there is a positive value of intercept coefficient () means that if
all the independent variables remain constant then NII will be 73.178 percent carrying a viable
economic meaning that generally there exist around 73.178 percent NII in SCBs of the
country. Slope coefficient of NPLR is -1.880 that means if NPL ratio increases by 1 percent
then the NII will be decreased by 1.88 percent and it is statistically significant at 1% percent
significant level. In case of Deposit growth rate it is found that there is inverse relationship
between NII and DPG as NII

decreases by 0.899 percent due to 1 percent increase DPG where at 5 percent significance level
it is accepted. Again, the slope coefficient of NPL growth is 0.091 that states if NPL grow
by 1 percent NII increased by 0.091 percent that is statistically insignificant at 10% significant
level. So there exists no strong negative relationship between Growth rate of NPL and NII.
Here, slope coefficient of PRVG has a value of -0.074 show a negative relationship with NII.
Due to 1 percent increase in provision growth rate NII will be decreased by 0.74%.
 b
Table : 3 ANOVA
Model Sum of Squares df Mean Square F Sig.
a
1 Regression 723.482 4 180.871 17.517 .020
Residual 30.976 3 10.325

Total 754.459 7
a. Predictors: (Constant), PRVG, NPLR, NPLG, DPG
b. Dependent Variable: NIIR

The variables used in the regression are potentially endogenous as they are simultaneously determined
through banks balance sheet constraints and are correlated with each other. From the ANOVA table
(Appendix I) it is found that comparing calculated F value of 17.517 with table value at 2%
significance level the null hypothesis of H0 (1): There is no significant impact of Non-
Performing Loan Ratio on profitability (Net Interest Income) of SCBs for last 8 years, H0 (2): The
impact of Deposit Growth Rate on SCBs profitability (NII) is statistically insignificant for last 8
years, H0 (3): The impact of Growth Rate of NPLs on SCBs profitability (NII) is statistically
insignificant for last 8 years, H0 (4): The impact of Provision Growth Rate on SCBs profitability
(NII) is statistically insignificant for last 8 years are rejected. So, with 98 % confidently we can
conclude the statement that alternative hypothesis of H1 (1): There is significant impact of Non
-Performing Loan Ratio on profitability of SCBs for last 8 years. H1 (2): There is significant impact of
Deposit Growth Rate on SCBs profitability (NII) for last 8 years. H1 (3): There is significant impact
of Growth Rate of NPLs on SCBs profitability (NII)H1 (4): There is significant impact of Provision
Growth Rate on SCBs profitability (NII) for last 8 years are accepted .
 Chapter- 6

Findings Recommendation Conclusion

6.1 Findings :
Findings of NPL are such as Stopping Money Cycling, Earning Reduction, Capital Erosion,
Increase in Loan Pricing, Frustration etc. As a result, the values of security are increased and the
risks of financial recession also see a rise. Amplifications of the effect of NPL are as follows:

1. NPL can lead to efficiency problem for the banking sector. It is found by a number of
economists that failing banks tend to be located far from the most-efficient frontiers, because
banks do not optimize their portfolio decisions by lending less than demanded.

2. There is a negative relationship between the non-performing loans and performance

efficiency. So, increase in NPL hampers the performing loan. Most of the cases, it occurs when
there is an adverse selection. Averse selection is asymmetric information problem that occurs
before the transaction. For example: big risk takers or outright crooks might be the most eager to
take out a loan because they know that they are unlikely to pay it back. Because adverse
selection increases the chances that a loan might be made to a bad credit risk, lender might
decide not to make any loans, even though there are good credit risks in the market place.

3. NPL creates the Credit Crunch situation. Credit crunch is a phenomenon that banks ration loan
disbursement and new credit commitments in order to protect, but add more risks. Banks treat
loan as an asset. They expect return from it. If loans become NPLs then banks have lack of fund
to give loan according their commitment or banks could give loans at their previous interest rate.
Clients have to pay more. So loans may be defaulted. Credit crunch also increases the rate of
NPL.

4. There is a cyclic relation between poor economic condition and the depressed economic
growth as follows:

a. During the crisis moment, in order to restore the credibility among creditors and depositors,
failing financial institutions not only try to expand their equity bases, but also reduce their risk
assets or change the composition of the asset portfolio. Because of such defensive actions, the
corporate debtors are always targeted, thus the economic growth is being stalled overall. Bank
try to collect loans amount as fast as possible and most of the banks have huge number of
corporate clients so they try to recover those loans as early as possible to reduce risky assets.

b. Money cycling gets stopped due to increase in NPL. Slow flowing of cash always has negative
impact on any business.

c. When the NPL is increased, interest earning gets stopped. But the cost of fund and the cost of
management are not stopped. To run the management cost along with the cost of fund, the
existing lending price has to be increased. Suddenly increased rate of interest makes hard the
return of bank money for a new borrower. So rate of investment will be lower.

d. NPL affects opening of LC (Letter of Credit). International importers always choose healthy
condition of the exporter's bank. Worse health condition of the bank affects the opening of new
LCs. Low rate of LCs makes low bank earning.

5. NPL exists as a natural consequence of lending behavior. When banks re-balance their
portfolio, they decide on the degree of risks they will tolerate for a given level of expected return
according to their risk preference because banks have to keep 10% of their risk weight asset as
capital or 400 cores. Banks treats loans as a risky asset. If the risk is high, banks will expect high
return. When the level of non-performing loans goes beyond a certain point banks cannot accept,
and then it affects bank's re-balancing actions. So, when NPLs cross the boundary of the above
threshold, they start to spawn negative effects on more lending.

6.NPL has a positive relationship with interest rate. When NPL increases, loan which is treaded
as asset becomes more risky. So that the rate of interest also increases to get sufficient retune
from the loan to cover the risk.
6.2Recommendation

1. No compromise with due diligence in the sanctioning process. Keeping in mind

"prevention is better than cure."Banks should take high collateral. If a borrower defaults
on a loan, the lender can sell the collateral and use the proceeds to make up for the loss.
The security or collateral provided must be valued by proper agency or put up on a
regular mark to market valuation process.

2. Action plan for potential NPLs. Banks should have some step to collect the NPLs loan.
At the end banks should go to Artha Rin Adalat.

3. Identification of highly risk sensitive borrowers in the credit portfolio. Banks should take
information about the clients before giving loans. Banks could go Bangladesh Bank to
collect the information and verify the financial statement carefully from reliable sources
to identify the risky borrowers.

4. Identification of geographical area-wise risk sensitivity. Banks should identify the clients
according area wise thats mean in Bangladesh, there is some places where growth rate is
low or rate of repay rate is low.

5. Targeting high value end NPL accounts (having exposure of Tk. 5.00 crore and above)

6. Prompt action on credit reports

7. Capacity building of officers and executives in the recovery department. Banks should
give proper training to employee. So they can handle loans properly. If there is short of
experience employee, bank should recruit experience employee for recovery department.

8. A robust risk management culture, with a well articulated risk management policy can
help the institutions to avoid such loan default.
6.3 Conclusion :

Our banking sector is characterized by low profitability and inadequate capital base because
there are lots of banks in Bangladesh. Banks revenue comes from spread (Lending rate
borrowing rate).But there is huge competition among banks. So the profit is minimum. 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 11.90% in 2014 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, and asset securitization 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.

Bibliography:
Books:
Basely, Scote & Brigham, F. Eugine, Essential Managerial Finance 13th edition,
Thomson (New York).
Peter S. Rose Commercial bank Management fifth edition, McGraw-Hill .
Websites:
http://www.Investopedia .com
http://www.oppapers.com
http://www.ask.com
website www.bangladesh-bank.org
http://www.Financialexpress.bd.com

Articles :
Ahmed, Shahabuddin. 1998. Ethics in Banking, The First Nurul Matin Memorial
Lecture, May 6, Bangladesh Institute of Bank Management, Dhaka. Unpublished.

Asian Development Bank. 2003. Regional and Country Highlights - Sri Lanka.
Bangladesh Bank. 1991. Loan Classification Manual.
Bangladesh Bank. 2003. Annual Report, 2002-2003.

Bangladesh Institute of Bank Management (BIBM). 2000. Studies in Bangladesh

Banking: Series 1, BIBM, June: 67.

Banking Regulation and Policy Department, Bangladesh Bank. BCD and PRPD
Circulars, 1989-2001.

Bernanke, Ben and Lown, Cara. 1991. The Credit Crunch. Brookings Papers on
Economic Activity 2: 204-248.
Software:
Megastat Excel(2003), (2007); SPSS (2007) .
Appendix :

Compartive positon of NPL Table- 1 :

Urban Rural Total

NCBs 21.99 % 37.36 % 59.35 %
SBs 2.45 % 17.15 % 19.60 %
FCBs 0.56 % 0% 0.56 %
PCBs 15.22 % 5.27 % 20.49 %

NPLs to total loan ratio Table-2 :

Year NCB SB PCB FCB Total

1997 254,540 20,110 114,230 21,240 410,120
1998 277,560 21,330 129,720 27,370 455,980
1999 307,380 25,530 135,450 31,220 499,580
2000 342,390 29,660 155,180 41,940 569,170
2001 375,790 38,170 188,730 48,240 650,930
2002 (Sept.) 400,662 44,880 222,300 60,256 728,098

Capital to risk weighted assest Table-3 :

Types of Bank Urban Rural Total

NCB 276,318 124,344 400,662
SB 24,303 20,577 44,880
PCB 202,556 19,744 222,300
FCB 60,256 - 60,256
Total 563,433 164,665 728,098

NPLs Ratio of Types of banks table-4 :

Bank 2007 2008 2009 2010 2011 2012 2013 2014 End
types June
2013
SCBs 21.4 22.9 29.9 25.4 21.4 15.7 11.3 23.9 26.4
DFIs 34.9 33.7 28.6 25.5 25.9 24.2 24.6 26.8 26.2
PCBs 5.6 5.5 5.0 4.4 3.9 3.2 2.9 4.6 6.6
FCBs 1.3 0.8 1.4 1.9 2.3 3.0 3.0 3.5 4.7
Total 13.6 13.2 13.2 10.8 9.2 7.3 6.1 10.0 11.9