Non-performing loans: The burden on an emerging economy

The banking sector has a significant role in enabling business activities. Banks furnish loans to businesses and mobilize savings which promotes growth and development. Sustainable development of an economy requires a system that facilitates the business sector. A thriving financial sector increases employment, exports, cash liquidity and overall cash flow. The part played by the financial sector in the economy makes it imperative for the legislature and judiciary to review and strengthen the legal instrument which supports better performance of financial institutions in our country.

The fundamental challenge faced by loan advancing financial entities is lack of good governance. According to the International Monetary Fund (IMF), insufficient internal control and poor risk management in financial institutions allow distribution of loans to unviable borrowers resulting in default. The recovery process of the loan also slows down because of the growing trend of loan rescheduling, restructuring and regulatory forbearance. The aggrieved parties are reluctant to settle through legal redress due to the insufficiency in the legal framework.

A non-performing loan (NPL) is formed when banks cease to receive interest and/or instalment payments from loans as scheduled by contract. NPL has been alarmingly high in our country for the past few decades. Henceforth, Artha Rin Adalat Ain 2003 was enacted to govern law on loan recovery and Artha Rin Adalat was established to serve justice to the financially aggrieved in Bangladesh. A highly formalized court was designed to enable quick disposal of cases. Nevertheless, the effectiveness of Artha Rin Adalat has been a subject of contention.

Alternative dispute resolution (ADR) was incorporated in the Artha Rin Adalat Ain 2003 as a substitute method of settlement of the dispute between the parties. ADR is an umbrella term for various methods of settlement out of court, which may include mediation, arbitration, negotiation, consolidation, and so on. Actively practising ADR successfully mitigates the complexity and delay of litigation, simultaneously ensuring a harmonious relationship among the parties.

The Artha Rin Adalat Ain 2003 specifically enumerated court-annexed mediation as part of litigation but it was unable to bring any significant change in Bangladesh. But it failed to achieve its goal as the total NPL ratio continued to rise. Every fiscal year, an enormous amount of fund is tied up as NPL, the NPL ratio stood 9.3 percent against Tk1,024,498 crores in June 2020. Expert opinion is that the ADR mechanism could be an important tool to reduce and recover the NPL provided it is incorporated and implemented prudently.

The possible reasons behind the failure of mediation in Artha Rin suits may stem from the erroneous codification of mediation. Mediation involves a neutral party, i.e., a mediator to facilitate the settlement process. The mediator does not possess the authority of decision making, the settlement is assisted by the mediator to help the parties to reach a mutually acceptable decision by themselves, which later becomes binding on all the parties involved. However when the parties fail, they have the autonomy to walk out of the mediation at their will.

In the existing law, the Artha Rin Adalat refers cases for mediation at the post-trial stage. Mediation is an out of court settlement incorporated to speed up the disposal of  cases, but ironically it is only referred when the parties are faced with the challenge of procedural complexity and cost of litigation is exhausted. Moreover, post-trial mediation takes place after the publication of auction, which further makes the situation hostile between the parties making it more difficult for the parties to reach a mutually acceptable common ground. Consequently, the borrowers tend to use mediation as a time killing-tool which makes the essence of mediation redundant, defeating the purpose of ADR.

To make mediation more fruitful, it may be mandated prior to the initiation of any adversarial stance. As a pre-action protocol, it should take place before auctioning of the properties. This will allow the parties to find shared interest, where the parties will be more likely to create a win-win situation in a decision. Furthermore, both parties will be benefited by avoiding the cost and complexity of litigation.

Arbitration has not been included in the Artha Rin Adalat Ain by the legislators. The act may be amended to bring Arbitration within the domain of the definition of "Adalat". An arbitral tribunal has the authority to pass a unilateral judgment within three months' time span and an arbitral award has the enforceability of a court decree inside the jurisdiction. It is also enforceable beyond the country border through the New York Convention. Bangladesh is a signatory of the New York Convention along with 158 other countries.

A system may be created through which the aggrieved party can follow and pursue recovery settlement in chronological order, as mediation settles disputes ensuring the persistence of party autonomy. It can be the action of the first instance by an aggrieved party, which will be assisted by professionally accredited mediators under the supervision of licensed institutions. Upon exhausting the pre-trial mediation, parties with claims up to Tk 25 crores can go for Arbitration. The adversarial litigation could be the remedy of last resort and the court could impose an exemplary fine on parties who avoid the ADR before coming to Courts.

To ensure fairness and further speed up the process, Artha Rin Adalat can be empowered to appoint executive authority who may be vested with powers to take charge of the mortgaged property and handle auctioning, sale, distribution of the proceeds of the sale, among the creditors and also cease property unlawfully retained by creditors. Such an entity can be listed or registered as a member in the court record.  

Failure to recover payment ignites a whole new protocol in the Bankruptcy Court against the defaulters and the course of action is lengthy and cumbersome for the aggrieved parties. Furthermore, it has been observed that the defaulters tend to file writ petitions in the high court against interim orders of the Artha Rin Adalat which causes delay to the loan recovery process. This may defeat the purpose of establishment of the Artha Rin Adalat itself. Therefore, it is of utmost importance to provide some finality to the aggrieved parties, which may be done by issuing interim orders against Artha Rin Adalat decisions sparingly.

An inadequate legal system that fails to provide solutions regarding loan recovery will lead to a decrease in bank revenue. As a result, loan interests for the business organizations will increase, further lowering the investment demand in the country; as a consequence, the economy will suffer. Hence addressing the lapses of the legal system is of utmost importance.

The author is a Barrister of Lincoln's Inn (UK) and Advocate (Supreme Court of Bangladesh)

Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard.