Non-performing loans weigh down banks

Sanderson Abel Business Correspondent
Access to bank loans has been a growing discussion over the last few years since the advent of the multi-currency system. Banks responded to the wiping off of company balance sheets by extending short-term loans to businesses and individuals in a bid to play their most important intermediating function in the economy between holders of surplus funds in the economy and those that need the funds for productive uses.

However, the banking sector has been beset by a growing problem of non-performing loans. These are loans that are not being repaid according to original terms of agreement between a borrower client and the lending bank. These non-performing loans have now begun to constitute one of the most important factors causing reluctance by the banks to provide new credit.

It is argued that the non-performing loans are one of the major causes of the current economic stagnation problem. Each non-performing loan in the financial sector is viewed as an obverse mirror image of an ailing unprofitable enterprise in the case of a business loan, or an uncouth individual in the case of a personal loan.

However, NPLs become a huge cost on the economy when they begin to interfere with the normal financial intermediation role of banks.
If the non-performing loans are kept on bank books and are continuously rolled over, the resources are effectively locked up in unprofitable sectors; thus, hindering the economic growth and impairing the economic efficiency. Money must go around in the economy if the economy is to function properly and grow.

Here are few implications for the failure to honour bank loan obligations:

• Banks increasingly tend to carry out internal consolidation to improve their asset quality at the expense of distributing new credit. This limits the access to new loans by both existing and new borrowers.

• Banks are forced by law to raise their provision for loan losses. These decrease the banks’ revenues and reduce the funds available for new lending. Bad loans also represent a charge on bank capital as these are subtracted from a bank’s capital base before it is allowed to lend depositors funds

• The cutback on loans impairs the corporate sector as they have difficulties in expanding their working capital by augmenting it with loan funding, effectively blocking their chances of resuming normal operations or growing their businesses.

• Unavailability of credit to finance firm’s working capital and investments might trigger the second round business failure which in turn exacerbates the deteriorating quality of bank loans, resulting in a re-emerging of banking or financial failure.

• Non-performing loans can lead to efficiency problem for banking sector because banks don’t optimise their portfolio decisions by lending less than demanded. What’s more, there are evidences that even among banks that do not fail, there is a negative relationship between the non-performing loans and performance.

• The phenomena that banks are reluctant to take new risks and commit new loans is described as the ‘”credit crunch” problem. A “credit crunch” is a disequilibrium phenomenon. It is present when banks are unwilling to lend, especially when a firm with profit- able projects cannot obtain credit in spite of low interest rates (lower than the expected marginal products).

Credit crunch results in excess demand for credit and hence credit rationing, where loans are allocated via non-price mechanism. Eventually, it imposes additional pressure on the performance of the monetary policy.

• Perhaps, the most important reason why borrowers should pay back loans acquired from banks is that the money that banks lend out is not the banks money but depositors money. That is you and me. When people take their money to the bank, they expect to get it back.

When the bank lends to money out so that depositors can earn a bit of interest on the deposits, the bank hopes that the borrower will repay.
Failure to pay back loans therefore impairs the ability of a bank to meet the withdrawals demands of its depositors. This is one of the major reasons for banks demanding that when a borrower takes money from a bank. The bank has a legitimate expectation to get the money back. Failure by borrowers to meet this end of the bargain is resulting in the erosion of confidence in the banking system.

• During a credit crisis, 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 assets portfolio.

As a result of such defensive action, the corporate debtors are always targeted and their access to credit is reduced, thus stalling the overall economic growth.

• Another natural consequence of failure to repay credit is that your company or you as the directors may be blacklisted and you will have a bad credit record. This limits future borrowing and business opportunities.

It is imperative therefore that economic players play their role in financial intermediation by ensuring resources extended to them in the form of loans are actually paid back so that the country can remain in a sound economic condition.

It is clear therefore that the result of a poor economic condition and depressed economic growth, the level of NPLs will increase creating a vicious cycle.

The weaker corporate sector makes banks more reluctant to provide additional credit, and with insufficient capital, the production sector is further weakened, resulting in decreases in aggregate demand leading again, to an even worse borrowers’ condition, which creates more NPLs.

Sanderson Abel is an economist. He writes in his capacity as senior economist for the Bankers Association of Zimbabwe. He can be contacted on [email protected]  or on 04-744686, 0772463008