Robust recovery and foreclosure laws — a need of hour

Outstanding and ever growing Non-Performing Loans (NPLs) are impacting the health and performance of the banking industry. If left unchecked, it is poised to become a major challenge for the embattled economy.

NPLs sap the capacity of banks to cover and divert defaulted amounts to meet the pressing demand for loans in vital sectors such as agriculture, housing and for small and medium enterprises (SMEs) as well as developed areas of the country. Historically, several banks/ development finance institutions (DFIs) have collapsed under the burden of the high level of such distressed loans.

Stringent recovery and foreclosure laws are the backbone of a healthy banking system. The faster recoveries are processed, the healthier the sector is. However, as per recent data released by the State Bank of Pakistan (SBP), the quantum of NPLs in Pakistan's financial sector has swelled to an alarming level of Rs783 billion as of June 30, 2019.

These NPLs work out to be six percent of Pakistan's GDP and have reached a crisis point. Amidst weak economic conditions, high interest rates, the increasing cost of doing business, the economy is suffering badly. An overburdened legal system, which at times seems to be more conducive for defaulters, constitutes the prime reason for the hike in NPLs.

While the banking sector look on with alarm at the surge in NPLs, courts are functioning at a slow pace given the scale of the impending catastrophe. This is especially true in the case of big ticket defaults where borrowers and legal counsels are prone to take full advantage of legal procedural ifs & buts to frustrate recovery efforts. As such, owing to such delays, banks' recovery suits, particularly those related to properties, take years to resolve in the courts.

If one glances over the mortgage financing scenario in Pakistan, we clearly witness that we lag far behind (both internationally and regionally) in our Housing Finance to GDP ratio. This is primarily due to a lack of strategic prioritization on the part of Banks/DFIs in extending loans to this critical sector which gets at least 40 other industries working in creating job opportunities and economic prosperity of the country. It goes without saying that weak foreclosure laws in Pakistan have been the main reason of driving the banks away from housing/ mortgage financing during the last decade or so.

The inclusion of Section 15 in Financial Institutions (Recovery of Finance Ordinance), 2001 (FIRO) empowered the Banks to sell mortgaged properties, without any recourse to the Court. However, Supreme Court of Pakistan also declared it "ultra vires" to the constitution of Pakistan in December 2013 primarily due to lack of reserve price mechanism, the opaque process of auction of the properties, as well as the point that Banks themselves were acting as seller, purchaser, auctioneer and beneficiary all at the same time.

Later on, in August 2016, the Government of Pakistan re-enacted a new & improved Section 15 by addressing all the objections of the borrowers/ courts. In addition to this, the Federal Government also framed/ promulgated Rules which are tilted in favor towards clients/ borrowers and it has also addressed many concerns of the superior courts and lawyers of the customers. With reenactment of this Section, it was expected to have a positive impact on the credit expansion particularly to the housing sector. Nevertheless, the Honorable Lahore High Court suspended this new Section upon filing of an application by a loan defaulter. The case is still pending without any conclusion in sight.

While banks were engulfed with cumbersome and unproductive legal proceedings for recovery of their loans in the Courts, the introduction of “Willful Default” provisions as an offence in FIRO Amendment Act, 2016 became a ray of hope to see light at the end of the tunnel.

Subsequently, nomination of FIA as an investigating agency, to examine criminal complaints of the banks, had further strengthened the belief that long standing dues can be recovered from the defaulters who despite having the capacity are unwilling to repay their dues. However, these revisions/amendments in FIRO Act 2016 have also been unsuccessful so far owing to status-quo orders granted by High Courts, slow paced proceedings and lack of interest at FIA.

To encourage the banks to extend loans in the housing sector, strict and practical foreclosure laws like “Parate Execution” (implemented in Sri Lanka) should be introduced in the country. This is a procedural law which allows sale of a mortgaged property without going through court proceedings. The procedure is quick and it also gives the customer an opportunity to approach the bank during the interim period and settle the amounts due. By following this law, the mortgaged properties are transferred in the name of the bank at a nominal price, if not sold in the market. Nonetheless, the Bank is required to re-sell the property for adjustment of its dues and refund of excess money to borrowers.

In Pakistan, the revival and rehabilitation of potentially economically viable companies is virtually suspended owing to a variety of reasons. Therefore given the present overall economic situation, there is a dire need to take serious steps to make distressed companies financially & operationally viable. In view of this, if any law resembling "Parate Execution" outlined above is implemented in Pakistan, it may allow Banks to purchase such projects for onward selling to investors who have the capacity & willingness to run these sick units therefore generating economic activity and ensuring the repayment of bank's dues.

In conclusion, looking at the huge scale of NPLs, there can be hardly any doubt that the menace of NPLs needs to be curbed. It poses a big threat to the macroeconomic stability of Pakistan's economy and Banks are justified in demanding the expeditious disposal of their recovery suits as well as reforms in the recovery & foreclosure laws given that speedy disposal of bank's cases is a catalyst to recover public money from willful defaulters. Furthermore, if the Government intends to see PM's dream of five million low cost houses realized, it can only happen by enhancing mortgage lending capacity of Banks which must be underpinned with an effective and strong foreclosure framework in the country. The success of the PM's Housing Scheme depends upon it.