Profit statements

Banks allowed to profit from unrealized interest

The Bangladesh Bank has offered a mega discount for banks, allowing them to display unrealized interest income as profit if borrowers only pay 25% of their current year owed amounts.

In addition, banks can transfer an additional 1% allowance that they were asked to keep against late loans last year, subject to full collection of amounts owed by borrowers.

The central bank has issued a circular giving instructions on how banks will transfer interest incurred on defaulted loans into their profits for 2021.

The moratorium facility on loans outstanding for two years will end in December.

The new circular will help banks show high profit by taking unrealized income on the balance sheet for 2021.

As banks take a high risk of showing unrealized interest income as profit, they will have to maintain an additional 2% allowance against these default loans, according to the circular.

The risk of this process of turning unrealized income into profit is that if borrowers do not pay the rest of the amount, it will increase defaulted loans. An increase in defaulted loans will increase provisioning needs and high provisioning needs will eat into profits.

The ability to take unrealized interest into account will allow banks to declare a high dividend for the current year.

The circular instructs banks that borrowers who have paid 25% of their amount payable will not be marked as defaulters.

Borrowers, who will not pay 25% of their amount payable by December of this year, will be marked as in default, according to the circular.

The Bangladesh Bank introduced the circular at a time when banks were already spending heavily on dividends, posting inflated profits and saving less for future risks, causing a provision shortfall.

Another risk is that default loans are already on the uptrend, breaking through Tk1 lakh crore in September of this year.

The key indicators of the health of the banking sector have already started to deteriorate with the increase in defaulted loans, the worsening of the provision deficit and the erosion of capital.

Most banks made strong profits even in the midst of the pandemic, with no allowances under the moratorium on outstanding loans, but many of them spent in dividends instead of saving for on rainy days, which led to a widening of provision shortfalls coupled with an increase in loan defaults.

Only a few banks maintained higher allowances to offset losses from defaulted loans.

General allowances are balance sheet items representing funds set aside by a business as assets to pay for anticipated future losses. For banks, a general provision is considered as additional capital in the first Basel Accord.

The latest default loan statement from September shows that only eight out of 42 private banks held a good amount of excess provisions above Tk100 crore.

The total excess allowance of private banks declined from Tk 1,000 crore to Tk 3,586 crore in September compared to December of last year, as rising default loans increased the reserve requirements for banks.

Private bank default lending jumped to 5.47% in September from 4.66% in December last year, according to data from the Bangladesh Bank.

The increase in defaulted loans has also eroded the capital base of private banks.

Even though the banks seemed reluctant to maintain an additional allowance during this time of crisis, they were rather anxious to receive the dividend.

Even in the midst of the pandemic, banks haven’t compromised on paying cash dividends – they paid higher cash dividends for 2020 than the year before, which makes directors happy.

Out of 31 private banks listed on the Dhaka Stock Exchange, 22 have paid cash dividends for 2020.

The dividends declared by most of these banks for the last year are higher or similar to those of the previous year.

The evolution of profits for the current year shows that the banks have made good profits but have not maintained adequate provisioning.

Growth in earnings per share of private banks has reached 154% in the first nine months of the current year, and most banks have achieved profits above 20%.

Despite good profits, some banks were in deficit.

For example, Standard Bank recorded 154% profit growth in January-September this year, but the bank was in a provision shortfall amounting to Tk 100 crore in September.