Economy, Business And Markets

Learning to Take NPLs by the Horns

Learning to Take NPLs by the Horns Learning to Take NPLs by the Horns

Japan has gone through a banking crisis. The Keiretsu – a type of informal business group revolving around a bank – dominated the Japanese economy over the last half of the 20th century. The Keiretsu model of business had follies that led to an asset price bubble and the accumulation of non-performing assets in Japanese banks.

As a result of the crisis, non-performing loans soared in the Japanese financial system. However, Japan managed to bring down non-performing loans ratio in its banking system from 8.7 percent in 2002 to 1.8 percent in 2006. The ratio for Iran's banking system is almost 13 percent.

In an exclusive interview with the Financial Tribune, Naoki Tabata, senior advisor to Japan Economic Research Institute, offered a way out of the current problem in Iran's financial system. Tabata was among key speakers at the 25th Annual Conference on Monetary and Exchange Rate Policy held last week in Tehran.

Look Into the Matter

First off, Tabata proposes executing strict on-sight inspection on each bank by the Central Bank of Iran. "Measure the magnitude of NPLs as well as value of collaterals held by banks." With the inspection of each bank's books, the central bank can then understand the depth and nature of each bank's bad credit, and then decide what can be salvaged and what should be written off as losses.

As for the depth of the inspections, he says that securities portfolios, computer systems, and even personal matters should be investigated by the central bank. Chairman and executive directors should also be interviewed and later informed of the inquiry's results.

The Losses

The next step is writing off the bad debt as losses. The non-performing loans should be written off the bank's balance sheet using the bank's capital. But, some of the bad debt can be revived or "might be written off in future". For these the bank has to set aside some money.

The major Iranian banks would become bankrupt if they were to write off such losses. Central bank statistics suggest the banks jointly hold over 938 trillion rials ($28.3 billion at market exchange rate) of non-performing loans. But many officials including the economy minister believe the real amount to be double that, as banks reschedule the due date on the loans to hide bad debt.  

Unavoidable Bailouts

To compensate banks' capital shortage, "the government should not hesitate to give government money to bad banks or buy NPLs from them," said Tabata. This way, a financial crisis from failing banks would be averted. "If government does not do so, the banking sector will continue to be very weak, and many banks would become bankrupt."

The money for the bailouts should come from "issue of long-term government bonds."

Afterwards, "president and senior executive directors should resign and a new management team should be designated by the authorities." Furthermore the central bank should monitor the banks through periodical on-sight inspections, to maintain full knowledge of their state until they return to financial health.

Let Them Fail

"As the result of the inspections, if the bank has no possibility to recover or restore then the government [should] push those bad banks to become bankrupt."

When questioned if the move could create a domino effect and lead to a banking crisis, Tabata responded: "This is an illusion of a false situation, and domino effect should be stopped by the government."

Reviving Roots

Considering that NPLs are in essence money borrowed by the corporate sector, the government should take necessary steps to return the corporate sector to profitability, so that they can repay their debt. "If the corporate sector continues to be in red, leading to the zombie corporations, NPLs will not return to banks," said the banking expert.

Iranian businesses have been hit by financial sanctions, which bar them from outside business, and also an economic recession, which is the result of poor fiscal and monetary policies. Furthermore, Iran suffers from heavy government intervention in almost all sectors of the economy. The combination has proved disastrous for Iranian businessmen.

To reverse the situation, government regulations should be minimized, the markets liberalized and obstacles to competition removed, said Tabata.

As added measures, the government may have to create a deposit insurance corporation to buy bad debt from the banks and handle their restructuring. It can also establish Investment funds to buy bad banks, to turn them around and resell them. To revive the private sector, which is suffering from a credit crunch, the government may also have to create companies to lend money to small and medium sized enterprises.