Why Parate Execution? Did Credit Quality Ignore?
Last week, the parliament of Sri Lanka passed a special amendment to the Recovery of Loans by Banks (Special Provisions) Amendment Act No 4 of 1990 which rules that parate execution only if the principal sum borrowed is over Rs 5.0 million.
The original bill was enacted by the parliament as government own banks in 1980s faced a grave crisis in relation to credit management in which they recorded a colossal volume of non performing credits, which threaten to the payment system of Sri Lanka and the financial stability.
To pass the original act, former General Manager of Bank of Ceylon, Mrs Rohini Nanayakkara was enthusiastic based on the Risk Asset Review Report prepared by the leadership of this writer and a credit management expert of Booz, Allen and Hamilton, Mr Ken Drop, who had excellent remedial management experience in CITI Bank Egypt. The risk asset review exercise assessed the quality of credit portfolio and rated the portfolio with a realistic rating system.
Current General Manager and former General Manager of Bank of Ceylon also worked with us and at that time due to extravagant non performing credits, the bank was in a near bankrupt situation, if the international accounting standard applied to the account reporting system of the bank. It was one way a threat to bank capital base and other way to customer deposits base and the bank was also in a difficult situation to compliance with international banking regulations imposed by Bank for international Settlements in 1984 that regulations were subjected to maintain 8% capital on risk weighted assets.
In terms of risk weighting, the 90 % bank credit portfolio contained risk requiring 100% capital. Although the government provided Rs 13 billion funds to recapitalize bank’s capital base, the procedure followed by the treasury was questionable to international risk analysts because the treasury issued a bond to increase capital of the bank and the same bank invested in the bond.
Was it a joke or a cheating, the decision should be made by readers. Later the bank accounted interest accumulated to this particular bond investment displaying higher annual profit of the bank and it appeared that accumulated interest were provisions or paper profit not realise liquid profits. When Mrs Chandrika Bandaranaike was the president and the Minister of Finance wrote sell this bond to public in order to get rid of the disgraceful transaction.
In this environment, there were two popular options to recover bad loans, one was through parate execution of assets of borrowers and other to write off bad loans by increase in bank capital base through privatising a part of ownership of the bank. At that time, choosing the option to privatising the ownership was an uncertain option as it would have risked the security of the country as Bank of Ceylon supported to import security equipment to country through its letter of credits and under the private ownership of the bank, it was assumed that the security of the country might be risked, if new ownership of the bank would be objected to financing for the import of security related items. Parate execution selected as the best option at that time quick recovery of loan as the legal system was not permitted to take quick legal action to recover bad loans.
Parate execution is an expate decision making process in which the borrower has less or no power to say its story at the court before execution. Parate execution may be against or contradicted with the legal concept of natural justice, which is an integral part of Sri Lanka’s legal system whether it is under Roman Dutch Law or Kandyan Law or English Law or Statute Law.
Natural Justice states that Audi alteram partem (Hear other side) and Nemo judex in causa sua (No man a judge in his own case). Parate execution was a privilege of government banks but such privilege was not entitled to private banks, which should go to court in order to take court order to takeover collaterals of borrowers to recover loans and the process is costly and time consuming.
Parate execution is the last option to a bank recovering bad credits and it should be able to prove that all possible action have been taken by bank prior to the notice of parate execution. Although it may be against the natural justice, parate execution is performed by banks and financial institutions in western countries as the covenants written in credit documents openly authorised by the borrower to parate execution.
It cannot blame to the concept of parate execution but it is a responsibility of the bank management creating an environment not arise parate execution maintaining credit quality of the lending portfolio by techniques of credit management. Many factor usually contributes for loan defaults. Economic and business condition environment of the country major factor influences to genuine credit customers because originally forecasted cash flow could be unattainable with the result of economic environment or natural disasters. This type of issued could be remedialised by frequent monitoring of credits without imposing parate execution.
Parate execution is risen when there is a weak credit management in a bank. During the Risk Asset Reviews of the Bank of Ceylon it found tremendous mistakes and dishonest acts done by bank employees sometimes top bank executives involved in corruptions. Many times banks attempted to blame politicians for none performing credits as they approved such bad credits under political duress.
Bank customers in Sri Lanka who cannot prove credit quality go to politicians and seek politicians’ supports to influence credit decision process. It is a true story in Sri Lanka and a considerable volume of non performing credits in banking system represents credits were originated through political duress and the problem is when this type of problems come to the bank how banks reacted or responded to such influences not approving credit but through the reporting process when banks operational manuals do not provide accurate procedures that have to be followed by the bank employees.
Does bank management frequently communicate with the regulatory authority and the minister in charge of government banks educating minister in charge and the regulatory authority for policy making purposes on the repercussion of such political duress to the payment system of the country and the status of banking system?
Banks provide credits to good customers using their capitals and liquidity gained by customer deposits. The government provide a large sum of current account deposits to banks, which are interest free funds and that advantage has no many private banks in the country.
Politicians of the country (government and opposition) are contributing nothing to the banking system to wrongly enjoy bank assets. When unqualified customers go to making undue influence credit decision making, it might lead to parate execution, if the customer fails to repay credits. Politicians are not above the law to prevent parate execution or influence on judicial system in relation to credits repayment matters.
When it talks about parate execution, other significant issue involves in the banking system is the integrity of bank employees who were engaged in credit management. During the risk asset review exercise, it was revealed many dishonest activities of bank employees and the financial statements of some corporate institutions indicated that commissions were offered to bank employees and custom officers and several bank credit officers’ names were in company payroll. No argument that such corrupt practice relegates government banks bad credit puzzle. Some bank employees prepared manipulated project reports and cash flow statements charging fee and later such project reports and cash flow statements were submitted them in the banks to obtain finance.
Although credit staff suppose to assess management quality of corporate through a specific test that involve in integrity of company management, credit staff did not demonstrate the integrity in credit analysis and structuring credits. Collateral assessment was quite manipulated and credit information used to evaluate customers was questionable and many times bank staff did not display fiduciary obligation when managing assets and liabilities of the banks.
There is a comparatively higher volume of bad loans in banks were generated by dishonesty of bank employees and there is less procedures to dealing with the accountability of credit management when top executives commit wrong doing in the banks. The banking system in western countries strongly concerns on the integrity of employees in regard to dealing with whole sale or retail packages because such corrupt practice negatively impact on the share price of the bank destroying shareholders’ wealth. Many instances parate execution issues emerge in banks when employees wrongfully manipulated asset values of customers.
Sometimes banks approved large sum of credit on clean basis such as temporary overdraft was crystal clear information that credit will be defaulted.
The next important issue leading to parate execution is lack of skills of bank staff to identify credit risks and to take effective actions to mitigate such risks in structuring credit packages. After cold war widely expanded market economic environment created oligopoly and intense competition among banks to maintain the market share. In such environment, credit officers need broad financial knowledge and skills to successful analyse corporate credits structuring purposes.
Most of bank staff in Sri Lanka are lacking these acumen and stewardship as the training system of the banks is outdated and focus to identify systematic risk according banks lending books. In modern world risk is non systematic and factors behind the risk may not be imaginable sometimes it is like subprime mortgage issue begun in 2007. The ability to identify non systematic risks is gained by the knowledge built through basic education and an employee’s continuing behaviour to acquire knowledge through research, reading and participation in workshops etc.
Many recruitees in banks are political Hench men without proper basic education and personal quality to gain skills for problem solving and the problems in recruitment process in Sri Lanka creates maintaining the integrity of staff members.
A classic example revealed in risk asset review was that a credit staff wrong way interpreted balance sheet information of a customer due to ignorance or dishonesty to providing millions of credit. The customer’s balance sheet’s capital, indicated as issued capital Rs 100 whilst the authorised capital was Rs 100 million.
The top executive who approved the credit did not know the difference between authorised capital and issued capital and ultimately the credit decision was made assuming that the customers was a high capital bearing valued relationship, but it was a liability to the bank. So parate execution can be incurred as a result of lack of skills of bank employees.
The major commandment of granting credit should be right assessment of credit quality and structuring the credit package to customer needs with appropriate covenants. After extension of credit bank employees used to ignore it and monitoring credit and remedial management entirely ignored until the credit become an issue to the bank.
Sri Lanka’s financial authority must understand that the banking problems in Japan early 1980s and 90s stagnated economic growth for more than 6 years and banking crisis in East Asian countries during the Asian crisis in 1997-98 forced to liquidate banks and undermine the economic renaissance begun under the market economic system. The encouragement of seeking bond finance through stock market may possibly avoid parate execution and pressure of banks. And bank customers are forced to maintain the credit quality of them to attract in investment in debt securities. Credit recovery through parate execution is expensive process to both parties but parate execution may not be avoided at certain level and however, it could be reduced if banks consider three factors explained above and take practical policy actions to address the issues.
- Asian Tribune -