There was a time when cheating a financial institution was considered a fashion and to some extent a status symbol. Defaulter of one organization is considered to be the defaulter of the whole financial sector.

QAISER NAZEER, Askari Leasing
May 21 - 27, 2007

One has to only mention in any gathering that one is employed with a financial institution and there will be no escape from some peculiar questions pouring thereafter.

How does one get a loan from a bank?
How does one get away without paying it back?

Granted that in many cases these are tongue in the cheek questions, however, they may be hiding a degree of truth also.

Is there really a privileged desire to cheat?
Do we want to borrow and not to pay back?
Are we a nation of defaulters?

The question arises, what is the true situation? If one talks to the borrowers, one only hears stories of harsh behavior and ruthlessness of banking officials. On the other hand if one talks to officials, there are never ending stories of attempts where borrowers tried to swindle the institutions.

Turn on the television; media is full of allegations and counter allegations by politicians, bureaucracy and ruling elite about robbing the financial institutions. Again, one says, what is going on?

The question is: why do loans go bad?

There are many controllable and uncontrollable factors, which can give birth to default. One needs to differentiate between professional defaulter and the borrower who is unable to meet his/her financial obligations due to reasons out of his/her control. Credit analysis tools and techniques cannot judge a borrower who is availing loan facility with an intention of default or someone who needs funding for genuine business needs. Extra skills are needed by the financial institutions to differentiate between the above two categories of the borrowers.

A borrower who is availing loan facility for business purpose may face liquidity crunch causing default. Change in business environment of borrower can disturb cash flows of borrower and ultimately he may fail to meet his /her financial obligations. Sometimes, disputes between partners and among family members may create financial distress for a borrower due to which, ultimately financial institutions have to suffer.

Business, political and regulatory environment also has tremendous influence over lending transactions. All factors play a role in the economy and have a subsequent effect on how a loan may perform. This may lead to a situation whereby a well performing sector suddenly becomes non -performing or otherwise. We are all witness to various situations where a sector, which was previously a star performer suddenly fell from grace and was rendered as non-performing sector. We can still remember the rise and fall and again rise of IPP (Independent Power Producer) sector. Same situation played out in cement sector among others.

A most recent example is of UTS (Urban Transport Scheme) in Karachi. In the UTS scheme of Karachi, financial institutions lended / invested lease amounts of funding as the basic business environment was considered conducive and profitable. This was made possible due to guarantee by district government along with subsidies, which had facilitated the same in view of large transportation requirement of busses. However, the whole scenario changed drastically with the change in local political government.

The new government with the primary motive of failing the scheme introduced by previously ruling political adversaries changed the whole framework. Even the cost of increase in fuel prices was not committed to be a pass through item, which made hereto a well performing and profitable scheme into a non-performing unviable business venture. The transporters were forced to park the busses due to increase in overheads and wash the hands off the mass transportation business.

What was the result? The whole business loss ended up in the lap of financial institutions, who are stuck with badly deteriorated asset having unfavorable market value.

Another common reason of default witnessed by Pakistani financial institutions has been over ambitious market strategies. Lending institutions are struggling to be market driven. They want bigger & more profitable portfolios. For this, tough targets are intimated to marketing force. In recent past, while trying to meet the lending targets, they chose to distribute money rather than lending prudently. This has been most visible in auto sector & personal finance, which were deemed as golden opportunities by financial institutions. In this process the banks lowered their risk management methodology or in some case they were fed misinformation by the frontline sales staff who were only motivated by commissions they would get on sale/booking of each case.

A prime example is the auto leasing where, in many cases, the assets (auto) is missing and in some cases even borrowers are untraceable. In the bigger picture who is to lose? Obviously it is the financial institution and through them, their depositors.

Another phenomenon seen in recent times is the case of personal finance, whereby the borrowers have faced exorbitant interest rates. These rates especially on credit cards are as high as 30 to 40%. Further more due to rapacious & predatory policies of Financial Institutions, a new reality has taken birth in Pakistan where people are caught in debt-trap & have no chance of ever getting out. This results in a situation where borrowers seeing no end, just go in default and refuse to make any payment. Leaving aside the debate of 'Riba' these rates would be classified as 'Usury' and would be banned in any self-respecting modern society.

Sometimes borrowers wrong decisions thus paving way for default. Wrong projections and perceptions of the project & mismanagement of working capital can also expose borrower to default. Government also has influence on repayment capability of a borrower by change in duty structure, abrupt withdrawal of subsidy, interference in terms of input cost/ price control can lead to default.

On the other hand, in many cases borrowers avail funding facility with out any proper due diligence and homework. Financial institutions are facing a common problem in lending where purpose of lending is different from actual usage. In many cases loans are acquired to settle liabilities towards other Financial Institutions.

Lack of documentation in SME or consumer financing is also a major cause, which has resulted in huge amount of bad loans. The quote "High risk high return" is quite true where financial institutions are motivated by possible gains and overlook the associated risks. Lending influenced by nepotism may also contribute to bad loan portfolio.

What happens when the loan does go bad?

Financial institutions apply moral pressure on the borrowers. If it does not work they try to realize the securities provided by the borrower for securitizing the loan. This forces the financial institutions to go to courts. Looking at the important influence of litigation on the lending activity, the legal framework is as follows:

Legal Environment of Pakistan

Our legal environment consists of following framework:

Companies Ordinance 1984: Based on English law and deals with companies operating issues.

Debt Recovery Law 1997: Was not very fruitful & was not fulfilling the needs of lenders, as far as speedy recovery is concerned.

Recovery of Finances Act 2001: Enhanced form of 1997 law & perceived to be totally lender biased and aimed to speed up the recovery process for Financial Institutions.

National Accountability Bureau: Evolved just after military take over in 1999. Instead of providing support to Financial Institutions in recovery the main focus was to eliminate corruption. This organization also faced and is facing criticism on the grounds of its weak working draft and limitations and way of working with an effect of compromising with defaulters.

Current list of financial laws either in draft or pre draft stage are as follows:

State Bank of Pakistan Act:
Banking Companies Ordinance:
Corporate Rehabilitation Act:

Institutional setup is as follows

Civil Courts
District Courts
High Courts
Supreme Court
Specialized Courts & Tribunals
Accountability Courts
Banking Courts
Federal Shariat Courts
Labor Courts
Taxation Tribunals
Federal & Regional Ombudsman

How does it work? The process is as under:

Financial institutions rely on Banking Courts normally, in case when a loan goes bad. Due to improvement in Recovery Law, getting a Recovery Suit decided is quite easy for financial institutions provided that loan was disbursed after meeting all necessary legal requirements.

In case of default, financial institution under the Recovery of Finances Act 2001 may institute a suit in Banking Courts by presenting a 'plaint' duly supported by a verified "Statement of Account". On a plaint being presented before Banking Court, summons in prescribed form are served to the 'defendant' (i.e. the borrower or customer, as the case may be) through the bailiff or process server of the Banking Court. Upon an application made by a defendant / borrower within 21 days of service of the summons, the Banking Court may give leave to defend the suit, if Court deems it justified. Otherwise the Court issues a decree in favor of the Financial Institution. The Banking Court has the power to grant an interim decree. A suit in which leave to defend has been granted to the Defendant is under the Banking Act, to be disposed off within 90 days from the day on which leave was granted and a decree is to be granted in that regard.

Like all other cases, Recovery Suits also depend on quality of documentation held by the financial institutions at the time of sanctioning loan facility. Financial institutions ensure securitization of the transaction by completing necessary legal requirements which may help financial institution at the time of default to effect recovery through court.

To speed up the recovery process and to facilitate lending environment, 29 Banking Courts have been established working at different stations. After the decree, the case moves for execution and final realization of stuck up amount. The customer has the right to appeal based on nature of the case.

Despite the improved legal framework, Recovery remains an issue for the financial institutions. For financial institutions, time consumed in recovering outstanding amount from Banking Court is not satisfactory.

In litigation, financial institutions rely on lawyers. How can one judge the loyalty of a lawyer? How can one ensure attendance of lawyer in the court for hearings? There is hardly any control. In most of the cases lawyers send their juniors to represent in court for hearings. Proper follow up and representation both, by the lawyer and the financial institution speed up the litigation process. In most of the times there is no representation from financial institution at all. They just take the story given by the lawyer as God's truth.

In litigation more or less financial institutions have to pay the cost by foregoing their penalties (late payment charges). Court deems it to be interest over interest and unfair (PLD-2000-KHI 246 & BCD circular 32). Instead of late payment charges courts are allowing Cost of Funds (Section 3 (2) of Financial Institution Recovery of Finances Act 2001). In most of the cases Cost of Funds allowed by courts is lower than the Cost of Acquiring Funds from money market. Funds remain blocked till final realization and financial institution has to bear the cost. The value of returns deteriorates due to the time value of money & opportunity cost.

In a nutshell litigation does take time but ultimately financial institution manages to recover their over-dues provided that the transaction was securitized at the time of disbursement.

Where does the customer stand in case of default?

We can say that our borrower is not well aware of the consequences when a default occurs. It does not make much of difference whether there is a willful default or the borrower's repayment capacity has been disturbed by some uncontrollable factors. Credit Worthiness is the biggest intangible asset of any individual or a company and in case of default or litigation borrower/company definitely loses credit worthiness, which has no substitute.

Customer has to face recovery officials at home and at the office or it may be in public gatherings, causing mental torture to a defaulter. There was a time when cheating a financial institution was considered a fashion & to some extent a status symbol. Now default is thought of as a crime and the defaulter has to pay a lot like credit worthiness, other than default amount.

Credit worthiness is becoming an important asset. It is not to be destroyed. Defaulter of one organization is considered to be defaulter of the whole financial sector.

Financial institutions do try to help the defaulters who seek help themselves. Financial institutions try to avoid the above lengthy and expensive way of recovery by all means. Financial institutions are always ready to bargain or settle with borrower out of the court. But this is only possible when borrowers want to settle their liabilities.

Coming back to the original question:

How does one get away without paying it back? I should say gone are the days when it used to happen. A friend of mine used to say, one pays for the thrill one gets!