Dealing with non-performing assets

Before going into the depth of the problem, let us first define what are non-performing financial assets? According to experts, non-performing assets are debt instruments whose obligers are unable to discharge their liabilities as they become due. Here the term debt instruments refers to both loans and bonds. Now another question could be asked: what is the typical situation that breeds non -performing assets? The answer is: non-performing financial assets are by products of financial crises. Rising interest rates (raising the burden of debt service), economic slowdowns (eroding the viability of borrowers) and exchange rate depreciation (increasing the liabilities of borrowers with unhedged positions in their foreign currency borrowing) can all severely undermine the capacity and sometimes the willingness of borrowers to continue servicing and to repay their debt. Also in an environment like Bangladesh where regulation is ineffective and enforcement is weak there are a lot of politically dominant borrowers who are not willing to pay their debt intentionally.

The financial crises of 1997 to 1999 witnessed a more than threefold increase in the nonperforming assets in most Asian crisis countries. If not given proper attention to resolve the problem of non-performing assets it could deepen the severity and duration of financial crisis. It can also complicate macro economic management by tying up resources and impeding the resource allocation process, thereby prolonging the economic stagnation. In addition to it nonperforming assets can thwart economic recovery by weakening the financial system, whose dynamic financial intermediary role is critical for the resumption of economic activities.

Against the backdrop of unprecedented rise in the volume of non-performing assets, widespread failures in both the corporate and the financial sectors, and the largely underdeveloped asset markets and inefficient legal system how, can Bangladesh resolve the problems of non-performing assets? At present there are only two directives that are often given on the part of our central bank to the banking sector regarding non-performing assets. Firstly, writing off the bad loan through the loan-loss provisioning and secondly, settling the issue in the court. As the credit management framework of our banks are weak most banks are unable to invest considerable resources in the review of loan performance. As a result there is improper loan valuation and loan-loss provisioning and weakness in our legal system make it difficult to ensure rights in foreclosing and disposing of collateral thus obstructing quick settlement in the court.

In an economy where non performing assets have accounted for 30 percent of the total banking assets the above mentioned two directives have long been proved ineffective in reducing non-performing financial assets in our banking industry.

Where old approaches have failed in containing non-performing assets new approaches could be tested to resolve them. For the policy makers there are two such approaches to consider. One is the creation of asset management companies, another is out of court centralised corporate debt workout frame works.

Asset management companies are public or private entities whose main function is to take over the nonperforming assets of distressed financial institutions. Asset management companies are generally founded on the supposition that they can help facilitate financial restructuring and maximise the recovery of the nonperforming assets at the same time. The Aasian crisis of 90's saw an expansion of the traditional mandates of asset management companies, particularly with respect to the types and the number of institutions they were designed to deal with. By April 1999, government-owned asset management companies in Indonesia, Malaysia, Korea and Thailand had taken over assets whose face value was equivalent to 20, 17, 10 and 17.5 percent of the GDP of these respective countries.

Definitions
Broadly defined asset management is the process whereby non performing assets are first identified and organised into one of the four categories of action (selling, recovering, restructuring and writing off according to their individual characteristics) and then resolved. Asset management policies are any institutional arrangements or techniques that facilitate this process:

a) To sell a non-performing asset, the market for such an asset must exist and if no such market exists it must be organised. The sale of non-performing assets facilitates diversification of risks and reallocation of resources.

b) To recover a non-performing asset, the holder of the asset initiates a process, often legal, by which a part or the whole of the value of the asset can be recouped.

Out-of-court corporate debt restructuring
In most countries, when a debtor has failed to meet its liabilities as they become due, the insolvency system provides the creditor with the option to initiate either liquidation or rehabilitation procedures. Creditors often opt for rehabilitation when the restructuring of the operations or of the balance sheets of the debtor will enable them to recover more than they would expect through liquidation.

There are three different approaches to the rehabilitation of corporate debt: (i) Court supervised company reorganisation or liquidation -- seizure and liquidation of its collateral or sale of other assets in the possession of the assets obliger. (ii) To restructure a non-performing asset, the holder of the asset enters into negotiation with the assets obliger with the aim of strengtheing the ability of the obliger to service and eventually to repay the principal. (iii) To write off a non-performing asset, the holder of the asset takes a loss equivalent to its book value and removes it from the balance sheet.

Objectives: Successful asset management policies are guided by well defined objectives i.e. facilitation of financial restructuring, high rate of recovery, prompt resolution, normalisation of asset markets etc.

Prerequisites: Critical to the success of asset management polices is the supporting environment, whose design should be aimed at strengthening the ability of the market to carry on the asset resolution process and reducing dependence on government-led initiatives.

The most famous of the centralised out-of-court work out methodologies is the "London Approach," named after an informal frame work developed by the Bank of England during the recessation in the early 1990 to help steer corporate workouts in the United Kingdom. This frame work has been the basis for the development of similar frame works in Korea, Thailand, Indonesia, and Malaysia, despite very important departures in each of these new frame works from the original London Approach.

The London Approach is a frame work that is flexible and adaptable and rest entirely on voluntary acceptance by the banking community. The main elements of the London Approach are :

*Banks should remain supportive on hearing that a company with which they have a lending arrangement is in a financial difficulty.

*Decisions about a company's longer-term future should be made only on the basis of comprehensive information which is shared among all the banks and other parties to a workout.

*Banks should work together to reach a collective view on whether and on what terms a company should be given a financial lifeline.

*The seniority of claims continues to be recognised and there has to be an element of shared pain-equal treatment for all creditors of a single category.

Conclusion :
Non-performing assets are a manifestation of weakness in the corporate sector and an immediate source of problem in our financial sector. The phenomenon of nonperforming financial assets has a deep negative effect on macro economic stability of the country. So, instead of ineffective approaches new approaches must be formulated in the context of a comprehensive framework to deal with the difficulty. Before testing new approaches for the restructuring of the financial and the corporate sectors policy makers must remember that our existing politico-legal system is not equipped to deal with the problems of the nonperforming assets. It needs urgent overhauling. With an inefficient judicial system both approaches are likely to lead to outcomes that are neither the most efficient nor the most optimal in a supportive environment.

Ali Ahmed is a banker.