Banks want penalty interest against default loans back

Banks have requested the central bank to reinstate the penalty interest against defaulted loans to encourage good borrowers and discourage bad ones or wilful defaulters.

They made the call after the central bank's latest circular lifting the lending rate cap gave no instruction on penalty interest, which the banks have been charging against classified loans as per the central bank's previous circular issued in 2020.

The Association of Bankers, Bangladesh (ABB) has recently sent a letter to the Bangladesh Bank, highlighting the confusion and expressing their desire.

In the letter, seen by The Business Standard, the bankers' association wrote that in the circular issued on 24 February 2020, the central bank directed banks to charge borrowers a maximum of 9% lending rate, as well as a maximum of 2% extra penal interest on classified loans besides regular interest. Besides, the then-existing interest rate of 7% on pre-shipment finance – which an exporter can access before sending goods to a buyer – was kept unchanged.

However, the latest circular of the central bank dated 19 June 2023 lifted the 9% lending rate cap and made the previous 2020 circular null and void. That is why, banks now cannot charge the penal interest on these classified loans, reads the letter.

"No further instructions were provided regarding the above matters in the recent Bangladesh Bank circular on uncapping the lending rate. Bankers now want a clear direction on the penal interest on classified loans and rate of pre-shipment export finance issue" according to the letter.

The head of a bank's credit risk, wishing not to be named, told TBS, "A loan goes into an overdue period when the repayment period expires. At that point on, banks start charging penal interest. After the overdue period, the loan gets classified. Banks can levy penal interest on classified loans as well. This practice began long ago."

Noting that many banks do not impose penalty interest on classified loans, the official said, "Loan recovery becomes problematic if more interests are imposed on classified loans. However, imposing penalty interest on overdue loans increases the chance for those loans to become regular."

Managing directors of several banks, on condition of anonymity, told The Business Standard that if penal interest is waived against defaulted loans, it will be unfair to customers who pay regular loan instalments. Because, according to the new rules, interest will be imposed at the same rate against both default and regular loans.

Besides, loan defaulters will be encouraged through such facilities as they have to pay reduced loan instalments without the penal interest being charged. Deliberating these aspects, we have requested the central bank to consider the matter, said the bankers.

Ali Reza Iftekhar, managing director and CEO of Eastern Bank Ltd (EBL), told The Business Standard, "The amount of default loans in the banking sector is already mounting up and banks have to suffer a lot. My opinion is that penal interest can be charged against defaulted loans. This will encourage regular customers." 

According to central bank data, the total default loan in the banking sector stood at Tk1.32 lakh crore in March, which was 8.80% of the total outstanding loans. It was lower in December last year at Tk1.21 lakh crore, which is 8.16% of the total outstanding.

Bankers said banks have to keep a provision against these loans at a fixed rate for those loans that default. These provisions have to be kept from the profit of the bank.

Banks set aside 0.5% to 5% of their operating profit against regular loans, 20% against substandard classified loans and 50% against doubtful classified loans. Moreover, a 100% provision is required against loans classified as bad or loss.

According to bankers, if the maximum penal interest of 2% is imposed against the total defaulted loans (Tk1.32 lakh crore) outstanding of March, the banks get about TK2,500 crore in interest income. Otherwise, banks will be deprived of this income.

According to data from the Bangladesh Bank, though the amount of default loans in the country's banking sector is increasing, the recovery of such toxic credits saw a decrease of around Tk2,000 crore quarter-on-quarter in the first three months of this year. Default loans rose by Tk11,000 crore in the January-March quarter, while banks were able to recover only Tk3,314 crore.

For the last three years, borrowers have enjoyed various facilities for the repayment of loans. There was a moratorium on loan repayment in 2020 and 2021 due to the Covid pandemic.

Although the moratorium was withdrawn at the beginning of 2022, borrowers received a loan repayment exemption in that year due to the Ukraine-Russia war.

The central bank withdrew the loan repayment facilities at the beginning of this year, but it could not hold on to this position.

Recently, the Bangladesh Bank relaxed loan repayment for businesses that took short-term demand loans from banks. The borrowers with unclassified demand loans will be allowed to repay 50% of their instalments payable for the April-June quarter of 2023.

Mostofa Azad Chowdhury Babu, senior vice president of the Federation of Bangladesh Chambers of Commerce and Industry (FBCCI), welcomed the central bank's move of withdrawing the penalty interest.

"Banks do not take action against those who default on big loans. They take action against those who default due to unavoidable circumstances," Mostofa said.

"With many borrowers already struggling to make repayments, the imposition of penalty interest will make repayments even more difficult," he said.

Pointing out that banks are creating wilful defaulters with loans given under fictitious names or businesses, the FBCCI senior vice president said banks should reschedule default loans and give businessmen an opportunity for repayment. This will reduce the overall bad debt of the banking sector.