Asia's bad loans: It's time for a reality check<\/p>\n
Jack Rodman, Ernst & Young, The Asahi Shimbun, Tokyo<\/p>\n
A recent report from Ernst and Young's Asia Pacific Financial
\nSolutions Group suggesting that Asia's nonperforming loan (NPL)
\nproblem is much worse than generally perceived has triggered a
\nwave of objections from the region's central banks, national
\nasset management agencies and other institutions.<\/p>\n
Our Nonperforming Loan Report Asia 2002 said that NPLs on the
\nbooks of Asia's financial institutions currently total more than
\nUS$2 trillion, equal to almost 30 percent of the region's gross
\ndomestic product, and up 33 percent in the past two years. Our
\nestimate is double the official estimates of central banks and
\nother government institutions. It apparently has resurrected a
\nlong-simmering debate over the depth and extent of Asia's NPL
\nproblem.<\/p>\n
Asia's banks and governments are under tremendous political
\npressures to understate the magnitude of the NPL problem, keep
\nNPLs off their books, and minimize the amount of NPL loan loss
\nreserves. Banks continue to extend payment terms when loans come
\ndue and to provide money to large borrowers to keep their
\ninterest payments current.<\/p>\n
Their hope is that troubled borrowers or Asia's troubled
\neconomy will recover and make them "whole again." The problem is
\ngetting worse, not better. Borrowers don't want to put good money
\ninto troubled assets. Banks don't want to foreclose on the
\nassets; consequently, they have no legal authority to act as
\ncustodians to protect the value of their collateral.<\/p>\n
And the value of the asset continues to deteriorate, which
\nreduces the amount that the bank could recover when it is
\neventually forced to dispose of the loan. It migrates down the
\nclassification ladder from substandard, to doubtful or loss.<\/p>\n
Government agencies such as the Korean Asset Management Co. in
\nKorea or the Financial Sector Restructuring Authority in Thailand
\ngot off to a great start by gathering the NPLs from failed
\nfinancial institutions in their countries and offering them to
\nforeign investors at market-clearing prices.<\/p>\n
However, some borrowers and banks demanded higher prices,
\nwhich investors refused to pay. This impasse led to the formation
\nof asset management companies (AMCs) to take the bad loans from
\nbanks and "warehouse" them for future resolution through
\ndisposal, restructuring, joint ventures or securitization.<\/p>\n
We considered all loans, other than normal loans, as NPLs in
\nour computation. This included "impaired loans." An "impaired
\nloan" is one in which the lender must assess the borrower's
\nability to repay the loan when it comes due. If the loan cannot
\nbe refinanced, then the lender must look to the borrower's
\nbalance sheet to determine if the borrower has sufficient liquid
\nassets to repay the loan. If the borrower's assets are all tied-
\nup in the business, and the borrower has insufficient resources
\nto repay the loan in full when it becomes due, the loan is
\nimpaired.<\/p>\n
This requires banks and regulators to classify it according to
\nloan classification standards in each country and to set aside
\nappropriate loan loss reserves. However, the process of
\nidentifying "impaired loans" is extremely complex, time-consuming
\nand requires the financial institution and bank regulators to
\nmake a series of complex judgments about the borrowers business
\nprospects, estimates of cash flow, valuation of the market value
\nof collateral, assess the strength of the guarantor (if there is
\none) and weigh many interrelated facts to arrive at an
\nappropriate loan classification and loan loss reserve.<\/p>\n
Unfortunately in Asia, there are few people within the banks
\nand government agencies with the experience and expertise to
\nassess and evaluate all of these complex factors. Furthermore,
\nbanks are often skeptical that troubled borrowers are providing
\nthem with reliable information on which to make these judgments.<\/p>\n
We went to great lengths to accurately assess the real
\nestimate of NPLs in the financial markets in Asia by applying our
\nown assessment of international best practices comprised from
\nseveral international agency regulations, including International
\nAccounting Standards, BIS, Basle and others, for loan assessment.<\/p>\n
Resolving Asia's NPL problem will require more diligent
\nefforts by governments and financial institutions. It is the role
\nof government to safeguard the financial system. If that means
\nadditional capital injections in the banking system, so be it. If
\nit means changes in bank management, then such action is long
\noverdue. Furthermore, banking regulators and accounting firms
\nwill have to be more diligent to ensure that bank financial
\nstatements identify the extent of nonperforming loans and that
\nappropriate loan provisioning has been recorded.<\/p>\n
Instead of focusing on our estimates, I suggest that
\ngovernments, central banks and financial institutions focus on
\nthe problem itself. Whether NPLs are nearly 30 percent of GDP or
\n15 percent, they constitute a serious issue that has not been
\nadequately addressed. But the region's central banks may not be
\nable to address it on their own. We believe it would be
\nappropriate role for the World Bank, Asian Development Bank and
\nthe IMF to provide logistical, technical and financial support to
\nreform-minded governments who are committed to resolving this
\nlongstanding problem and returning Asia to the growth and
\nprosperity. The future of Asia and the global economy depends on
\nit.<\/p>",
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