Donald Joshua Jaganathan: Non-Performing Loan Resolution
Opening remarks by Mr Donald Joshua Jaganathan, Assistant Governor of the Central Bank of
Malaysia (Bank Negara Malaysia), at the World Bank Regional Conference on NPL Resolution,
Kuala Lumpur, 29 April 2019.
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It gives me great pleasure to be here this morning, to welcome you to this Regional Conference
on Non-Performing Loan Resolution. I would like to congratulate the organisers for successfully
gathering a selection of distinguished speakers to share their thoughts and invaluable
experiences. I would also like to take this opportunity to record Bank Negara Malaysia's
appreciation to Mr. Alfonso Garcia Mora and the World Bank for giving Bank Negara Malaysia the
opportunity to co-host this event in Kuala Lumpur.
The journey to a high-income economy is not always a smooth one. Often, there will be hiccups,
setbacks, and false starts. Those entrusted with the responsibility to steer the economy and the
financial system will often have to make policy adjustments and overcome one obstacle after
another. And at times, the economy or the financial system can overextend itself, similar to how
a ship can, midway in its journey steer in the wrong direction. The pullback in the form of
economic or financial crisis and the subsequent regeneration of economic activities is both trying
and difficult.
As most of you would know, economic and financial crises often result in high volumes of
impaired credit or bad debt that can linger and become a drag to economic growth and recovery.
During such periods many households and businesses default on their loan obligations resulting
in the erosion of banks' profit and capital. This adverse financial implication coupled with an
environment of uncertainty inevitably make banks more risk-averse to new lending and shift their
focus to NPL recovery as they seek to minimise losses.
Consequently, creditworthy households and businesses face greater difficulty in sourcing new
funds, thus further reducing their consumption and investment, resulting in lower economic
activity. Ultimately, this negative feedback loop dampens economic growth and destroys value as
viable businesses are unable to operate due to lack of financing.
Therefore, it is imperative for regulators and supervisors to ensure that these NPLs are managed
and resolved in a timely fashion. Decisive leadership on the part of authorities in addressing
rising NPL level in the financial system can slow-down the adverse economic impact, dampen
banks' knee-jerk reaction and jumpstart the economic machinery.
Like most countries, Malaysia has seen her fair share of financial and economic crises in the
past. Although twenty years have passed since the Asian Financial Crisis, it has left a legacy of
important lessons for those who are affected by it. Allow me to share with you some of the
lessons, which may be relevant to this conference.
Early preparation by regulators
There is a simple saying in the Malay language that goes like this - 'Sediakan payung sebelum
hujan' which translates into English as having an umbrella ready well before it rains. I am sure
that this is not unique to Malaysia and many of you here have similar phrases in your own native
language. As regulators, we always strive for the best but at the same time, must always prepare
for the worst. And the best time to prepare is during good times, when the sun is still out so that
our preparations can guide us to be clear-headed and decisive in the midst of turbulence or
stormy weather. In the context of today's conference, early preparation means that the national
authorities create a conducive environment so that NPLs can be resolved in a timely and orderly
manner during good times as well as during crisis episodes.
NPLs can be resolved either via market-led or government-led initiatives or through a
combination of both, depending on the nature of the situation and the resources available.
Regardless of the preferred approach, there are many areas within the NPL management and
resolution process that will greatly benefit from early preparation. For one, having clear legal
frameworks and regulatory requirements would significantly enhance the viability of market-led
NPL resolution. A clear legal and regulatory framework will shorten the sale and purchase
process, reduce the discount factor and improve the overall outcome of the NPL sale.
As regulators, early preparation in developing an active and liquid capital market and broadening
of investor base would increase the likelihood of a market-led approach to resolution. We can
also use this lead time to address common hurdles experienced during the NPL resolution
process such as valuation subjectivity, misaligned incentives of different stakeholders and tax
treatment of NPL write-offs.
However, despite authorities' best intentions, the market for NPL resolution is unlikely to be
sufficient to absorb the build-up of NPL during a crisis. Behaviourally, there will be players that
are unwilling to dispose of their assets due to the endowment effect, whereby they often
misguidedly believe the value of their NPLs to be much higher than the price offered by potential
buyers. Some market participants will take a wait-and-see approach and look towards the
authorities for either leadership or some form of guidance. In view of this, we, the national
authorities should always be prepared to play a more active role in NPL resolution.
In Malaysia's experience during the Asian Financial Crisis, the nascent capital market and small
investor base at the time of the crisis made a market-based resolution approach implausible. It
was quite clear then that the financial crisis would evolve into a full-fledged banking crisis if no
intervention measures were taken. Bank Negara Malaysia's intimate understanding of market
forces at play and the nature of crisis enabled it to swiftly coordinate with key stakeholders such
as the government, legislative bodies and the banks, which led to multi-pronged measures to
safeguard the financial system. In a few short months in 1998, we quickly established Danaharta,
our public asset management company (AMC); Danamodal, our special purpose vehicle to
address the erosion of bank capital; and the Corporate Debt Restructuring Committee (CDRC) a
mechanism to resolve debt of large corporations. Looking back, our decision to intervene early
and decisively gave us precious lead time to mitigate the crisis before the build-up of NPLs could
take a greater toll on the banking system.
Role of financial institutions in developing their internal capabilities
As we, national authorities and regulators strengthen our bases, it is equally vital that financial
institutions play their part and develop the agility and competency to manage their NPL resolution
process. Without robust internal capabilities such as a good IT infrastructure and sound risk
governance, financial institutions will be at a great disadvantage if they are unable to adequately
resolve their NPL book, especially during a crisis.
In this increasingly digitised age, financial institutions with good IT and risk management
infrastructures are able to swiftly assess their portfolio asset quality and risk. Adopting
technology does not only provide a competitive advantage during good times but also during
stress periods, whereby timely, accurate and actionable data are urgently required. A robust
information management system would allow banks to identify weak borrowers across the
various business lines and determine the estimated recovery value from each borrower in the
event of default. Combined with strong risk management, banks would be able to forecast the
build-up of NPLs in a timely manner, identify potentially impaired assets eligible for sale and
determine the appropriate value and the estimated loss that they would have to bear.
In this regard, recent global reforms in financial regulation have had a largely positive effect of
nudging financial institutions in the right direction by providing incentives to enhance their risk
management framework and IT architecture. With reforms such as Basel III, recovery planning
and IFRS 9, financial institutions have had to re-think their entire approach to risk management
and crisis preparedness. These reforms position financial institutions to better navigate during
stress episodes and reduce their likelihood of failure. As part of implementing these reforms,
financial institutions will have to continuously assess their existing systems and people readiness
and make the necessary investments to strengthen their defences. Such efforts will yield
significant benefits in the long-run as financial institutions become more agile and resilient.
Value Preservation
As regulators and banks strengthen their internal preparedness and coordination to enable timely
resolution of NPL, it is worth taking a step back to re-examine the purpose of NPL resolution. The
purpose, as we see it in Bank Negara Malaysia, is to ensure that financial institutions continue to
play an effective role in financial intermediation, thereby supporting the needs of the real
economy.
This brings me to my final point on value preservation. In approaching NPL resolution, national
authorities and banks ought to balance the need for a swift execution process against the need to
preserve value in good businesses that might be temporarily facing setbacks. In a crisis,
borrowers - whether individuals, small and medium enterprises (SMEs) and large corporates -
may experience temporary difficulty in meeting their loan obligation. In such an instance, banks
would be inclined to write-off these loans and to initiate foreclosure of collateral properties.
While a one-size-fits-all approach will yield short-term gains, in that banks will have a cleaner
balance sheet and are able to focus on lending, it carries negative unintended consequences to
the economy in the long-run, whereby good functioning businesses facing temporary setbacks
will be put out of business. Once dismantled, these businesses and their productive capacity
may never be fully restored especially in industries with high barriers to entry. And when the tide
turns, the crisis abates and the economy turns to recovery, authorities will be left with a slower
economic recovery as there are fewer firms to generate economic activity.
During the Asian Financial Crisis, Danaharta, our public asset management company was
cognisant of this and took a balanced approach in managing the NPLs. A soft-approach on viable
businesses to restructure their financing arrangement was coupled with a hard-approach that
began foreclosure proceedings on non-viable businesses. The Bank then later extended the
Corporate Debt Restructuring Committee (CDRC) and set up the Small Debt Resolution
Scheme (SDRS) which provides even small businesses an avenue to work out feasible debt
resolution without having to resort to legal and foreclosure proceedings. Meanwhile, for
individuals, the Bank set up the Credit Counselling and Debt Management Agency (AKPK) with
the aim of assisting individuals to take control of their financial situation via a debt management
programme. A balanced response of this nature is in my view critical, especially for emerging
market economies, as the dismantling of productive capacity will have adverse long-term
consequences on the economy.
Final Note
In conclusion, the experience from both the AFC and GFC has taught us, regulators and national
authorities a great deal about NPL resolution. Since then, there have been many new and recent
developments in the NPL management and resolution space. I look forward to hearing from
many of you of your respective country's experiences and unique viewpoints on this subject.
With that, I wish all of you a productive conference ahead and thank you for your attention.