One-way Monetary Transfer Mechanism from Taxpayers to Loan Sharks through NPL

Introduction

The Financial Institutions (FI), Banks and Non-Banking Financial Institutions (NBFI), operate their business by borrowing from general people and lending to parties ranging from entrepreneurs to individuals who finance their current projects or initiatives with the promise of repayment from their future earnings. The FIs play the critical role of intermediating between borrowers and lenders by always conducting two-way transactions (borrowing then repayment). The difference in the interest rates between these transactions is their income.

The mechanism

In this model, general public have two cash outflows for two inflows. Normally, general public supply the fund for investment and gets the repayment along with some interest earning. The other case is, the general public pay their appointed concerned parties (e.g. Government) in the form of tax payments for getting some civil services that they would not be able to manage by themselves otherwise.
So, for both FIs and general public, all the transactions are two ways (payment and repayment). Here a one-way monetary transmission is going on in the form of Non-Performing Loan (NPL). To define NPL, if any lender (can be called “Loan Sharks”) after taking loan, for any reason (capability or mindset or undefined power) does not repay the loan and the FI (despite having the legal authority) is not capable of recovering the loan, that loan is classified as NPL. We know what FIs do, is just to take fund from general public and lend it to borrowers, therefore, as per the definition, indirectly loan sharks are not repaying the general public. If this were the direct case, the impact would be straight forward and in a sense the situation would be better as general public would collect their money by themselves. But in financial system, this is not the scenario. In case of NPL, FIs deduct their profit and if that does not cover the amount they transfer the amount for the next year and continuous NPL incurring makes them go out of the market. But in every case, they ensure the repayment to the general public. So, the general public are not concerned about NPLs that FIs are incurring. The situation is interesting when the owners of the FIs are the concerned authorities appointed by general public. In that case, continuous NPL incurring does not make them go out of the market. They just write-off the NPL amount from their balance sheet and cover the losses from the tax that general public are paying for their civil services. So, what actually happening is that, general people are paying for the loan sharks indirectly for the NPL. In figure 1, we see the dark thick lines showing this transmission mechanism. As in the process, two intermediaries are there, the transmission of money to the loan sharks is not visible to the general public.

The devastating aspect of NPL is that the line of civil servicing from the concerned authorities to the general public becomes very thin (Figure 1). This means that a part of general public’s money that they are paying for their civil services is going to the loan sharks. How loan sharks are doing that? I don’t think this point needs any clarification.
For our country, the impact of such transmission is huge. This is one of the reasons, why we are not getting the minimum amount of citizenship benefits such as roads free from breakage and jam, drainage system capable of draining the rain water, mosquito killing initiatives for preventing Chikungunya, basic utilities such as gas and electricity at a stable and minimum price and several other mentionable services. According to a report of February 26, 2017, by The Asian Age, the amount that will have to be written off by the public banks for NPL is BDT 29,956 crore. By that amount we could have built more than a Padma Bridge, establish more than 5 metro rail projects as the same as in Dhaka across the country and taken the road and drainage system to a new level giving a little comfort to the citizens. This amount is even more than our education budget and pretty close to our budget for roads and bridges for the year 2017-18.
These are short run aspects but in the long run, the impacts get more chronic. General people will not be ignorant of this one-way transmission mechanism for long which will result in voluntary tax evasion, jeopardizing overall development process. The impact will also be on the concerned parties as they will eventually lose the trust of the general public. From the mechanism, we see the FIs are the tools in this process so they are impacted too in terms of profitability and trust. From the private bank perspectives, loan repayment evading tendency of the borrowers makes them more cautious in lending that their deposit remains under financed. This is also one of the reasons why we have such a huge amount of excess liquidity in the banking system. Real entrepreneurs are not getting their share of financial access. So, from all the perspectives the economy is losing.

Is there any solution?

How do we rectify this dreadful one-way transmission mechanism? It is easily shown in figure 2.
Just replace the loan sharks with real borrowers who can be held responsible if the loan is not repaid. Then all the transmissions become two-way and stabilized. But it is easier to be said than done even though as a young mind I can think of two ways. One is to strengthen the legal system over any other political or executive system at least for the financial sector (we can see such examples in our neighboring countries) so that borrowers can be held responsible timely and appropriately. The other is not to lend the loan sharks in the first place. But this is totally dependent on the integrity and willingness of the concerned parties. The private banks in our country has proven this fact. The differences in the NPL ratio of private and public banks (5.68% and 28.56% respectively) gives the indication of their level of integrity and willingness. Simply following the strategies of private banks, public banks can reduce their burden and stabilize the whole system. As a country, we are already facing the effects of this one-way transmission of money from the general public to the loan sharks. This is high time we broke our shackles from this devil chain and all we need is the mindset to follow the models that are already practiced and proven effective.