The Psychology of 'Default Now, Get Relief Later' is Raising NPL Risks

Kathmandu. As non-performing loans (NPLs) rise in the banking system, their impact is being felt not only on banks' financial health but also on borrowers' repayment behavior, according to bankers and financial sector experts. While targeted relief is necessary for borrowers in genuine economic distress, the practice of repeated loan restructuring, interest and penalty waivers, and debt write-offs may encourage a tendency to seek concessions after problems arise rather than repaying on time, they say.

According to bankers, loan restructuring or rescheduling is necessary to save businesses facing genuine economic problems. However, if concessions are granted uniformly without assessing the borrower's actual condition, it can weaken credit discipline.

'Helping a troubled borrower restart their business and giving facilities to a borrower who deliberately stops payment are not the same thing,' said one banker. 'If both are treated the same, even borrowers who repay on time may think that if they stop paying in the future, they will get some relief.'

The rise in NPLs in the banking sector is attributed to factors such as economic recession, business contraction, natural disasters, poor project selection, misuse of loans, changes in collateral value, lower returns on investment, and policy uncertainty. In addition, weak loan appraisal and the tendency of some borrowers to deliberately not pay have also exacerbated the problem, bankers say.

Financial sector experts, however, say the NPL problem should not be viewed solely in terms of banks' recovery capacity. According to them, it is equally important to consider what incentives loan repayment policies are creating in borrower behavior.

'If the economic outcome is the same for a borrower who repays on time and one who delays for a long time and later gets a waiver, the system sends the wrong signal,' an expert said. 'It can develop an expectation among borrowers that even if they don't pay now, they will get some relief later.'

Experts say past government debt relief practices in Nepal should also be viewed in this context. Through the budget of fiscal year 2065/66, principal and interest on loans of certain borrowers affected by natural disasters, conflict, and below the poverty line were waived, along with remaining interest and penalties on loans above a certain limit. While relief for genuinely troubled borrowers is necessary, experts say such programs, when they spread beyond the target group, can affect future repayment behavior.

Subsequently, provisions such as the 'Small Farmers and Entrepreneurs Debt Relief Procedure, 2069' also increased expectations of debt forgiveness, according to financial sector experts. They say that in the past, there have been situations where borrowers from one group demanded the same facilities received by another group and stopped repaying loans, insisting they too should get similar relief.

The same challenge was seen after the COVID-19 pandemic. When business operations were disrupted and incomes fell due to the pandemic, arrangements such as interest and fee concessions, installment deferrals, loan restructuring, and rescheduling were made to provide relief to borrowers. While such measures were necessary to save genuinely crisis-hit businesses, bankers say that when borrowers who had long failed to meet obligations also received the same facilities, it created a wrong incentive.

'The purpose of relief is to save businesses, not to develop a culture of not repaying loans,' said one banker. 'Borrowers who return to regularity after receiving relief and those who continue not to pay even after receiving facilities should not be viewed with the same lens.'

Experts say the interest rate spread and the process of refunding excess interest charged can also affect borrower behavior.