Written-off loans

This is the third time when the issue of written-off loans has been taken up at the highest echelons of the country. The first attempt was made by the interim government of Moin Qureshi when the lists of defaulters were also published in newspapers but the whole exercise proved futile.
The second attempt was made by the Musharraf government, when he included this issue in his six-point agenda but later on he backed out from it by saying that he was misinformed about the figures. Now this is third time when the Supreme Court has taken up this issue. Let us hope that this time some positive result would come out of this exercise.
It is a concern that since the first attempt made in this regard, the quantum of written-off loans has increased manifold instead of declining. Even now the success of this exercise, which is spread over 40 years (since 1971), is quite doubtful as the sponsors might have passed away during this long period, the factories sold out to some other parties, in most of the cases settlements might have arrived at under consent decrees of courts.
Accordingly the defaulters must have paid the agreed amount and the banks released the securities held against loans. Due to payments made under consent decrees and return of securities by banks, how can recovery of dues be reclaimed now? This is a big question.
Primarily the norm of "loan" is a misconception in this context. It is in fact an account that comprises of two parts viz., principal amount of loan and mark-up accrued thereon. Out of the reported Rs 256 billion written-off loans since 1971, the actual loan amount will not be more than 60% ie, Rs 153.6 billion while the balance amount will be the accrued mark-up/mark-up over mark-up which has been charged by banks in the quest to increase their profits despite continued default of the account.
This is not justified in any way. An example can be quoted in this regard. A loan of Rs 112 million was given to a company which amount increased to Rs 599 million over a period. Here the principal amount was only Rs 112 million while the balance amount of Rs 487 million was charged on account of mark-up income, mark-up over mark and mark-up reserve.
This quantum of mark-up might have taken years to reach to this amount during which period the account remained in default persistently. Despite this default, the bank continued to charge mark-up, which is not only unjustified but also violation of the State Bank's Prudential Regulations (under which income generation must be stopped if the account is in default for over 90 days).
WRITTEN-OFF LOANS ARE OF TWO TYPES
1) DUE TO STATE BANK'S PRUDENTIAL REGULATIONS: Under these regulations the account in default for over 365 days (one year) must be written-off to clean the balance sheet. However, writing off the account does not mean that the amount be forgiven. All efforts be made for its recovery but the fact is that once the account is written-off and taken out of the balance sheet, the management does not emphasise much for early recovery of this amount. As a result such amounts keep on piling up.
2) DUE TO SETTLEMENTS: Due to settlements reached between defaulters and banks/consent decrees issued by courts, certain portion of the defaulted amount is recovered while the balance is forgiven/written-off. Accordingly, the securities are also released by banks. This written-off amount is, of course, non-recoverable now.
REASONS FOR WRITING-OFF LOANS There are various reasons for writing-off loans like:
I) PROFESSIONAL INCOMPETENCY: Wrong appraisal of loan is detrimental to the project. If the machinery cost is overestimated, security is not properly related to the overall cost of the project, working capital is not adequate, equity is inappropriate, there are bright chances that the project would default, and the loan would be written-off.
II) VALUE OF SECURITY: With the passage of time, the security furnished against the loan amount keeps on depreciating while due to non-payment of dues, the liability keeps on increasing so much so the value of total security dilutes considerably against the total liability.
If the project is operational this disturbed ratio of high liability and low security may not matter much because the sponsor would come forward for some settlement of dues/save the project, sooner or later. But if it is closed, the only option left with the bank is to sell it out. Under this scenario, sales proceeds of the assets are usually too low to match with the total liability thus heavy write-off incurs.
III) GENUINE REASONS: Recession, high mark-up rate, high input cost, law and order problem, inconsistent government policies etc, are genuine reasons for losses/default/written-off loans.
IV) POLITICAL REASONS: In government-owned financial institutions, yes, political pressures also count while approving and writing-off loans but in private sector banks this factor is rare, still their quantum of written-off loans is very high.
V) LONG DRAWN LEGAL PROCESS: There are wilful defaulters also who earn from the project but do not pay back to banks. Banks are left with only one option for such projects ie, to take them to court. This process is so long drawn that it takes about 7-10 years in awarding decrees/ execution of decrees. The defaulters feel more comfortable if they are taken to courts as they pass 7-10 years comfortably. Later on they get the matter settled on their own terms. At this stage, banks have no other option but to accept whatever they (defaulters) offer.
Worst is the case with closed projects. During courts decision period of 7-10 years, the machinery is stolen, rusted and outdated. Thus after 7-10 years only the value of land is hardly realised which causes heavy write-off of the loans. This is the main reason that instead of waiting for courts' decision, banks prefer to arrive at some settlements out of court at the earliest. Whatever amount they get under the settlement is reinvested to reduce their loss. It has been observed that the writing-off loan amount is much less if settlement is arrived at initially than to wait for 7-10 years for courts decrees.
RECOMMENDATIONS The Supreme Court of Pakistan is kind enough to take notice of the huge written-off loans in the country. This exercise may be carried out from three angles: (a) to probe reasons for written-off the loans; (b) to help banks in their recovery of dues; and (c) to provide banks future line of action in this regard. My recommendations in this respect are as under:
a) The principal loan amount be first ascertained, and the banks be asked as to why unnecessary markup has been charged to inflate the figures/issue. The regulators should have checked it. This action is necessary to stop this practice in future.
b) As mentioned earlier, recovery from settled cases will not be possible, therefore, focus may be directed towards "unsettled cases" which are pending adjudication with different courts since years. Efforts be made to recover at least the principal amount. As reported in the press about 56,000 cases are presently pending adjudication with different courts. These cases involve a massive amount of Rs 215 billion as of December 2009. If only the principal amount is recovered out of this huge amount, it would amount to Rs 120 billion approximately.
c) The reasons for writing-off loans be also probed and responsibility be fixed for any wrong doing.
d) Finally, if this menace is to be checked in future, banks be allowed to take over management of the delinquent projects, soon after they default in payment of three consecutive installments of dues without courts interference. It will have a two-pronged effect: (i) the sponsors will remain alert in payment of dues and (ii) if banks take over management of such projects, it will be their responsibility to protect its assets which otherwise are pilferaged.
(The writer is former managing director of a joint venture financial institution and president of a Microfinance Bank. Presently he is chief executive of Entrepreneurial Services (Pvt) Ltd)
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