The Bhutanese Leading the way.
The World Bank’s latest report has put a spotlight on a growing concern for Bhutan’s financial sector, the rise in non-performing loans (NPLs).
Certain sectors, like tourism, construction, and manufacturing, were hit hard by the global pandemic, and are struggling to recover, leading to a significant rise in loan defaults.
The World Bank’s report highlights that the quality of loans has deteriorated, with an increasing number of loans failing to generate expected returns or being repaid.
The World Bank’s recommendations offer a detailed roadmap to tackle the challenges with series of strategic measures aimed at improving the management and monitoring of credit risks.
The first recommendation is the development and implementation of more robust credit assessment and monitoring systems. Currently, the Financial Institutions (FIs) often rely heavily on collateral to secure loans, which can mask the underlying risks associated with borrowers’ creditworthiness.
World Bank advocates for a shift towards more comprehensive risk-based pricing. This means setting loan terms and interest rates based on the borrower’s credit profile rather than just the value of collateral. By doing so, banks can better assess the true risk of each loan, and adjust their lending practices accordingly.
The report also emphasizes the need for improved guidelines for credit underwriting. Clearer and more detailed guidelines would help banks assess the potential risks associated with loans more effectively. This includes implementing stringent criteria for evaluating borrowers’ creditworthiness, and developing better forecasting models to predict loan performance.
Enhanced credit monitoring practices are also crucial. World Bank suggests that banks should establish early warning systems to identify signs of financial distress among borrowers before loans become problematic. Such systems would enable banks to take preemptive actions to mitigate risks and manage NPLs more effectively.
The existing legal and procedural mechanisms for handling insolvencies are viewed as outdated and inefficient.
According to the report, an updated framework would facilitate faster and more effective resolution of insolvencies, protect creditors’ rights more robustly, and reduce the economic impact of loan defaults. Simplifying these processes could help improve recovery rates on defaulted loans and encourage more proactive engagement with distressed borrowers.
Another key recommendation involves strengthening the financial sector’s regulatory framework. The report suggests that Bhutan should enhance its supervisory practices to better manage credit risks and ensure that banks adhere to sound lending practices.
This could involve transitioning from a compliance-based regulatory approach to a risk-based one, where supervision focuses on the actual risks faced by FIs.
The report also highlights the importance of fostering a more competitive banking environment. Currently, state-owned banks dominate the financial sector in Bhutan, which can limit innovation and competition. By promoting a level playing field between state-owned and private banks, the World Bank believes that Bhutan can encourage more dynamic and competitive banking practices. This could lead to improved lending standards and more effective management of credit risk across the sector.
Investing in the capacity of financial regulators, such as the Royal Monetary Authority (RMA), is crucial, the report recommends, and further states that enhancing RMA’s ability to oversee and regulate the financial sector, including implementing risk-based solvency requirements and improving regulatory practices. Building the capacity of financial regulators ensures they are equipped to manage the complexities of the modern financial landscape and address issues, like rising NPLs more effectively.
