It gives poor marks to the banks’ overall performance in comparison to their international peers and puts the blame squarely on the capital inadequacy of lenders and their inability to recover their non-performing loans.
Among other things, the PBO reckons low capital base, shareholders' aversion to increasing the capital of banks, flawed capital adequacy rules, obscure banking financial statements, declining profits, mounting accumulated losses plus inappropriate methods of capital increase used by banks as the most important reasons behind the capital inadequacy of banks.
The report says that the ratio of non-performing loans is higher than acceptable international norms. It also points to measures of some lenders to include piled-up non-performing loans in their assets running the risk of losing capital, Financial Tribune reported.
On the other hand, borrowers’ failure to repay debts will disrupt the cash flow and lead to disruptions in the key sector, the PBO warned.
It points to the unworkable methods of some banks to reduce non-performing loans by rolling over debts, saying that soured loans accounted for a massive 60% of the total arrears in fiscal 2017-18.
To cut the size of NPLs, the PBO proposes pursuing claims with the help of special courts and reforming bylaws that engendered non-performing loans in the first place.
Part of the positive points relates to the inter-bank market, which the report says witnessed a remarkable 106% growth in the 12 months compared to the year before. Inter-bank lending accounted for 31% of the short term banking finance during the period.
According to the PBO, in the previous fiscal the number of inter-bank deals was 38,101 worth 64 quadrillion rials ($571 billion).
Recalling past unsuccessful experiences, the PBO says arbitrary decision-making in allocating CBI financial resources had indeed increased the size of non-performing loans.
It points to the lenders’ negligence in evaluating the eligibility of loan applicants, their obvious indifference to technical, economic and financial viability of projects for which loans are allocated and banks’ sheer lack of motivation to collect bad loans as obstacles that impede the work of the banking sector.
The PBO touches on money creation as a phenomenon that resulted in runaway inflation stressing that liquidity has ballooned in recent years.
“Money creation by the banking system is visibly incompatible with the economic conditions that is characterized saliently by financial constraints and increasing limits on accessing bank credits.”
It continues to say that the colossal liquidity growth accompanied by the lower growth of base money is one of the impacts of high interest rates and the bulk of money arising from the high interest rates.
“When banks set interest rates on deposits higher than the interest they receive from loans and when the volume of non-performing loans expands exponentially, the economy inevitably creates money by paying interest.”
Reform Plan
The PBO is of the strong opinion that one way to fix the problem, which is mainly associated with “fictitious assets,” is by implementing a comprehensive plan of action to reform the structure of banks.
According to the report, purging fictitious assets from bank balance sheets, making financial assets transparent and updating financial reporting procedures to render it compatible with international standards are among key measures that must be incorporated in any future bank reform package.
Beside the above suggestions, the PBO proposes the following as solutions to cope with the raft of challenges pulling down the banking sector:
- Diversifying leverages for implementing monetary policies of CBI by developing appropriate mechanisms to launch an open market operation
Open market operations are a financial instrument through which central banks buy and sell securities in the open market to expand or restrict money supply.
As seen in the 2019-20 budget bill, the CBI will launch open market operations and trade in Islamic bonds issued by government for clearing its debts to banks.
- Drafting and implementing a plan for reforming the banking system. The plan should include revisiting banks’ balance sheets and other financial statements according to the framework provided by International Financial Reporting Standards.
- Identifying well-performing banks from their poorly performing peers in terms of their balance sheet and exercising punitive measures on banks that violate financial rules.
- Establishing a mechanism for liquidation, bankruptcy and mergers of banks that have failed to perform.
- Obliging banks to sell their assets and surplus property to companies active in non-banking sectors given the increase in prices in the asset market.
- Levying taxes on banks surplus assets as per the provisions of Law for Removing Obstacles to Competitive Production and Promoting the Country's Financial System, which bind banks to sell 33% of their excess assets annually under the oversight of the Money and Credit Council.
- Creating a robust assessment mechanism to help banks allocate loans to truly eligible applicants.
- Continuing measures to organize the informal monetary market and unauthorized credit institution.
- Banning loans to nonviable projects.
- Diversifying financial instruments to provide for assorted customers’ needs.
- Issuing Islamic bonds via banks backed by their own assets (also known as Sukuk), which should help increase capital.
- Launching open market operations by the CBI.
- CBI lending to banks in exchange for collateral.
- Categorizing banks as per their performance and treating them differently in terms of different indexes and conformity with CBI regulations.