Defaulting loans and a budding crisis

With most financial institutions closing their accounts for the year the full effect of the financial crisis is coming to the fore.

One of the visible signs of this phenomenon is nightly alerts on the national broadcaster of ordinary citizens being taken to court after being unable to pay their loans.

Though no bank or financial institution has yet openly admitted it, there are reports of a large number of people unable to meet their loan servicing requirements. In many of these cases the loans are becoming non-performing loans and bad loans. The volumes of these defaulters are also much higher than previous years.

Even big lenders who take a huge chunk of the loans are in the verge of defaulting on the loans or are already missing their payments.

The majority of these bad loans are due to the ongoing effects of the Rupee crisis which started from late 2011 and the Credit Crisis which started in early 2012. Both the Rupee and Credit crisis continue unabated and are still having a vitriolic and debilitating affect on most businesses.

Nearly all businesses in Bhutan needs rupees for imports while many need credit to run even day to day operations of their businesses, invest in growth areas, and meet other commitments.

Many of these businesses including ordinary citizens were  curtailed by the lack of credit and hence were unable to do or complete their projects, and as a result many find themselves unable to pay off their earlier loans.

In some cases clients are purposely not paying their loans even if they have the money as they are not sure of getting credit in the future.

What will predictably happen is by December end this year the bad loans will be known, as banks have to close their books for the year. Many clients may be given an extension of a month or two after which Bhutan’s financial crisis may have its full effect by January or February 2013 as clients, big and small, fail to pay their loans.

Already many Financial Institutions have started seizing higher than average number of collaterals like land, buildings and vehicles given in place of the loans.

The Banks will be fine if they can auction the collaterals and recover their loan amounts but in the current state of the economy with little or no money available most of these collaterals either will not get a good price or will not find buyers.

With land prices already on the decline such a glut of bad auctions will further affect land prices in the negative. This in turn will fundamentally affect the financial institutions as the majority of the collateral with them is land, rated on the higher values of the past.

One of the most affected people are those who took loans to build a house but could not complete it due the lack of additional loans. So as the building is not complete it cannot generate the revenue required and will thus not be able to service the loan. The bank here loses its loans while the house owner loses a valuable asset.

In a worst case scenario, which cannot be ruled out, a high accumulation of these bad loans can have a domino effect on the entire financial system and cause even a bigger financial crisis than the Rupee and Credit crisis combined.

In Bhutan’s worst case scenario, a high number of loan defaulters could cause a run on the banks as depositors would feel that their money is not safe in the banks and rush to take it out. Banks naturally will not be able to meet this rush  leading to financial instability.

This scenario of a run cannot be entirely ruled out as some banks have already had problems in paying withdrawals of high sums due to very low liquidity levels.

In the worst case scenario the financial collapse will have its affects on the real economy as depositors lose hard earned savings and the economy may not only come to a standstill but start a process of self destruction. Businesses will collapse and jobs will be lost in huge numbers.

Already the twin combination of the Rupee and Credit Crises have led to failing and downsizing businesses who are either not hiring or are firing employees wholesale.

So far, the Central Banks response, has been, to give a dose of medicine that should have been given over the years in one night and thus shock the financial institutions, in some cases, into a paralysis.

In a primarily government run economy the government’s response in the beginning, was to ignore the problem and when it finally accepted that it had a problem it blamed everyone else except itself. The government is still ignorant to this developing situation and its ramifications on the economy.

If the Financial Crisis does turn into the worst case scenario the damage will not only be financial and economic but also political with the 2013 elections just around the corner.

To find a solution the government must first recognize the larger problematic trend in these defaulting loans, and then come up with a comprehensive strategy in tandem with the RMA on preparing for any eventualities through monetary and fiscal measures.

QUOTE

“It’s the economy, stupid”
James Carville (Strategist behind Bill Clinton’s election victory in 1992)