Credit Recovery: Legal Measures

July 01, 2021

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 An Assignment on

Legal Measures
For Credit Recovery of Banks

This assignment has been submitted as a partial requirement

of Foundation Training Course for the Executives
of Standard Chartered Bank (SCB)

To the course Instructor Tahmina Rahman,

Assistant Professor, BIBM
&
Dr. Shamsun Nahar Momotaz,
Associate Professor, BIBM

By Royhan Shishir
Employee ID# 1538599

July 01, 2021

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 Acknowledgement

First of all, I would like to thank Almighty Allah to let me finish and submit my assignment. I

would like to express my gratitude to my course instructor Ms. Tahmina Rahman & Dr.

Shamsun Nahar Momotaz for giving me suggestion, constructive supervision and all kinds of

support for completing the report. I would also like to thank them for assigning me such a topic

that has helped me to enhance my knowledge in a truly unique way.

My immense gratitude to other course instructors for his cordial acceptance, impervious support

and cooperation despite their busy schedule. Without their cooperation and support it might not

have been impossible for me to complete the study.

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 Executive Summary

Banks provide important capital in the form of loan and advances. Sometimes these are
subject to non-repayment which is termed as credit risk, the chance that a loan will not be
repaid timely. Hence one of the main concern of the banks is monitoring and recovery of
credit. For which various non-legal and legal procedures are taken by banks to mitigate
credit risks to a certain point. This assignment intends to thorough study about the legal
procedures of credit recovery by financial institutions, especially in the context of banks.

After analyzing the data and necessary information, I have tried to cover the relevant
discussion on important topics, non-legal and legal measures in compliance with “Artha
Rin Adalat Ain, 2003” thoroughly.

To overcome the shortcomings regarding credit recovery, I hope banks of Bangladesh

will come forward for proper execution if CRM policies, so that they can overcome the
loss of Credit and earn a better margin.

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 Table of Contents

TITLE PAGE NO.

Cover page 1

Title page 2

Acknowledgement 3

Executive Summary 4

Table of Contents 5-6

1.0 Introduction 7

2.0 Theoretical Analysis

2.1 Bank Activities 8

2.2 Lending Principles of banks 8

2.3 Process of Lending 10

2.3.1 Sanctioning of credit 10

2.3.2 Apporval Authority 10

2.3.3 Documentation of credit 10

2.3.4 Disbursement of credit 11

2.4 Credit Risk Management 11

2.5 Credit Recovery 12

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 2.5.1 Stages of Credit Recovery 13

2.5.2 Effects of loan default and importance 13

of recovery of credit

2.5.3 Acts to be followed for legal procedures 13

2.6 Non-Performing loan (NPL) 14
3.0 Bad Debt situation from the context of Bangladesh 15

4.0 Reason of taking legal measures for credit recovery 16

4.1 Recovery Steps of Credit 17

4.2 Remedial Measures of Loan Recovery 18

5.0 Legal procedures 19

5.1 Serving Notices 20

5.2 Serving Legal Notices 20
5.3 Serving Notice to the Guarantor 20
5.4 Assessment and Identification of Securities in respect of
nature, quality and Valuation etc. 21
5.5 Attachment of other properties (if necessary) along
with the properties of Guarantor 21
5.6 Filing suits in the appropriate court for recovery of
outstanding loan balance 21

6.0 Constraints of Recovery 22

7.0 Recommendation for Improving Recovery Steps 22

8.0 Conclusion 23

References 24

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 Credit Recovery: Legal Measures

1. Introduction

Banking business during the recent time period has witnessed a sharp change in its
character and composition due to number of reformative measures and growing demand
for a variety of services. An addition to these changes is introducing Credit Risk
Management division that consists a part of the collection and recovery activities which
is separate from the other banking activities.

Bank is the most important financial institution in the economy. It plays vital role in the
economy by providing means of payment and in mobilizing resources. The economic
development of a country depends on the development of banking sector to a great
extent. The dependence of banking sector in modern economy is increasing day by day
because this sector ultimately contributes to run the wheel of development in a more
dynamic way. Today’s modern banks are not only providing traditional banking, rather
banks are expanding the options for providing financial services, thus making the
untouchable service touchable for their customers. The changing and expanding role of
banks has made the banking business more complex and competitive.

Banks provide important capital in the form of loan and advances. Sometimes these are
subject to non-repayment which is termed as credit risk, the chance that a loan will not be
repaid timely. Hence one of the main concern of the banks is monitoring and recovery of
credit. For which various non-legal and legal procedures are taken by banks to mitigate
credit risks to a certain point.

Credit risk is the possibility that a borrower or counter party will fail to meet its
obligations in accordance with agreed terms. Credit risk, therefore, arises from the bank’s
dealings with or lending to corporate, individuals, and other banks or financial
institutions. Credit risk management needs to be a continuous process that enables banks
to proactively manage loan portfolios in order to minimize losses and earn an acceptable
level of return for shareholders. It is essential for banks having robust credit risk
management policies and procedures that are sensitive and responsive to these changes.

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Bangladesh Bank issued guidelines on the Credit risk management function and it
emphasizes on – Policy guidelines, organizational structure and responsibility and
procedural guidelines.

2. Theoretical Analysis

2.1 Bank Activities

Bank lend public money which is repayable on demand by depositors so bank lends for a

short period. A banker must ensure that money will come back on demand or as per
repayment schedule. The borrower must be able to repay the loan within a reasonable
time after demand for repayment is made.

2.2 Lending principles of bank

Lending of cash to different sorts of borrowers is one among the foremost important
functions of banks. A serious portion of its fund is employed for this purpose and this is
often also the main sources of a bank’s income. However, lending isn't without risk. The
borrowers of a bank range from individuals to partnership, companies, institutions,
societies etc. The character of their activities, the situation of business, financial stability,
earning and repaying capacity, purpose of advance, securities all differ and their degree
of risks are also different. Therefore, a banker must take necessary precaution during this
process. A number of the vital considerations to be kept in mind by a banker during this
respect are- safety, security, purpose, liquidity, profitability, diversification, national
interest etc.

The five C’s of lending: The system employed by lender to measure credit worthiness is
known as the five C’s of credit. This system weighs five characteristics of the borrower
and conditions of the loan, attempting to estimate the prospect of default and
consequently, the danger of a loss for the lender.

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The five Cs of credit are discussed below:

Capacity: Prospective lenders will want to understand exactly how the borrower
plan to repay a loan. They’ll consider the income of the business, proposed
schedule of repayment and current condition of the borrowers’ existing loan.
Prospective lenders also will want to understand more about borrowers “backup”
sources of repayment.
Capital: Prospective lenders wish to see that the borrower have used a number of
his own assets and brought on personal financial risk to determine the business
before he ask them to offer him any of their money. They also want to understand
what proportion of debt the company can handle.
Collateral: This is often security that a borrower will provide the lender. He
pledges an asset, like home, to the lender with the agreement that the lender can
take it if he can’t repay the loan. This is often different from a guarantee, where
somebody else signs a document promising to repay the loan if he can’t. Some
lenders may require both.
Conditions: Lenders want to consider the economic climate in the industry and
other industries all of which affect the success of the business.
Character: Prospective lenders will want to understand that borrowers are
trustworthy enough to repay the loan. Lenders want to place their money with
clients who have the simplest credentials and references.

Before advancing loans and advances a bank should make sure that it will get the loan
back in time. Since many borrowers default in repaying loans, borrowers need to deposit
assets or give a guarantee as a testimony of the assurance of repayment. This asset or
guarantee is called the security of credit. Security is something of value given to a lender
by a borrower to support his or her intention to repay. In the case of a mortgage, the
security is the property that the loan is being used to purchase. It may include tangible,
intangible assets or even a personal guarantee.

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 2.3 Process of lending

Lending of credit by banks requires to follow some structured process that are discussed
below:

2.3.1 Sanctioning of Credit

A proper analysis based on valid & reliable information and data is very necessary for
sanctioning any types of loan/advance. Before approval/ sanction the banker should take
into consideration whether the proposed is remunerative and expected to be recovered or
not, compliance of credit policy with the govt. policy, credit restriction policy imposed by
central bank, banks budget, etc.

Here are some Factors that influence the sanctioning process:

 Type of loan/advance
 Nature of business/purpose
 Nature of security
 Amount of loan/advance (small or large)
 Nature of borrower (company, Firm, Individual)
 Nature & Tiers of Financial Institutions.

2.3.2 Approval Authority

The authority to sanction/approve loans must be clearly delegated to senior credit

executives based on their knowledge and experience to ensure accountability in the
approval process.

2.3.3 Documentation of Credit

Proper Documentation is essential to disburse credit and repayment of the credit in a

timely manner.

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 2.3.4 Disbursement of Credit

After assessing the borrower and successful documentation process the bank Disburse the
credit to the potential borrower.

2.4 Credit Risk Management

Credit Risk Management (CRM) is a dynamic process which enables banks to

proactively manage loan portfolios. Four major areas of CRM are:

 Policy— Lending guidelines

 Procedure — Evaluating viability and associate risks of business enterprises.

 Organizational structure— Segregation of risk taking and risk approving authority

 Responsibility— Decision making and accountability

Credit Risk Management Policy will be reviewed annually to accommodate necessary

changes in respect of risk mitigation. Thus bank’s effort is to maintain a loan portfolio
which is rewarding by taking calculated risk and ensuring quality of loans.

To strengthen the risk management practices of banks, Bangladesh Bank has provided
some revised guidelines on Credit Risk Management of banks. These guidelines provide
broad-based policy on the core principles for identifying, measuring, managing and
controlling credit risk in banks. Two types of CRM guidelines are stated below:

1. Policy guidelines:
 Lending Guidelines
 Credit Assessment & Risk Grading
 Approval Authority
 Segregation of Duties
 Internal Audit
2. Procedural Guidelines
 Approval Process

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  Credit Administration
 Credit Monitoring
 Credit Recovery

2.5 Credit Recovery

When a customer fails to make repayments on a loan, the bank takes action. Credit
recovery may include:

a) Referring the matter to a specialist debt recovery team with the bank

b) An external debt collection agency employed on behalf of the bank.

c) Sell of property over which the bank holds security

d) Seeking a judgement from the courts to enforce the debts.

Timely recovery of bank loans is important for various reasons and from various
perspectives:

 From the borrower's angle, the longer the delay in settlement, the outstanding
liabilities of the borrower increase; the likely penalties can also increase with
time. From the bank's perspective, the longer the delay in recovery, they lose the
chance to earn income in alternative investments, the safety and collateral may
lose value and hence may incur financial loss also. More importantly, the delays
in recovery proceeds can result in credit crunch within the bank and consequent
failure of the bank.
 From the society's angle, the productive assets are delayed, not producing value,
not creating employment and income.
 From the government's perspective, if such loan losses cascade and switch into
systemic risk and endanger the financial and economic stability, the tax payers'
money will need to be spent for rescuing these banks, otherwise the depositors,
meaning the standard, general public will need to bear losses. Thus, from very

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 many perspectives, timely recovery of loans is critical for the borrower, the bank,
the society and therefore the government.

2.5.1 Stages of Credit Recovery

Credit recovery stages are done as follows:

 Recovery Units (RU)

 NPL Account Management
- Autonomy of RU

 Accounts Transfer Procedures

- Downgrade to sub-standard

 NPL Monitoring
- Preparation & Approval of Classified Loan Review (CLR)

 NPL Provisioning and write-off

- Approval by HOC/MD/CEO

 Incentive Program
- For RU Account Managers

2.5.2 Effects of loan default and importance of recovery of credit

Capital and interest receivables are amongst a bank’s primary asset. Of these, interest
comprises a bank’s principal source of revenue and thus profit. Accordingly, from a
bank’s perspective it's essential that its borrowers keep their contractual commitments
and pay interest and capital as scheduled. Defaults are inevitable, but once they occur a
bank should take appropriate remedial action or, failing that, recover the outstanding
interest and capital promptly. If the bank neglects to try and do so the recovery process is
said to become lengthy, the impact on the bank could also be severe.

2.5.3 Acts to be followed for legal procedures

A proper process consisting of non-legal and legal measures is highly required for the
recovery of the money. Considering the matter, the government has enacted a special law
in the year 2003 for proper and speedy realization of money from the defaulters. This
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special law is known as “Money Loan Court Act, 2003”, popularly known as “Artha Rin
Adalat Ain- 2003”. It covers the matters regarding recovery of loans by financial
institutions. Only financial institutions such as banks and NBFIs can file cases against the
borrower under this act.

Practical problems arise with the fact that it is the case of financial institutions, there are
obligatory or willful defaulters who obtain huge amounts of loan and then stop repaying.
Sometimes funds are transferred abroad and the borrowers along with their family also
leave the country. In such a situation, a suit under this act is only beneficial to the extent
that an order for recovery can be obtained against the borrower, but no actual recovery
can be made.

If the borrower provides any cheque, then a criminal case can be filed if the cheque is
dishonored due to any specific reason, in accordance with the provision of Negotiable
Instrument Act, 1881.

2.6 Non-Performing loan (NPL)

A Non-performing loan is a loan in which the borrower is in default and has not paid the
monthly principal and interest repayments for a specified period. NPL (Non-performing
Loans) include those loans, which are showing signs of weakness in the credit quality of
the loans. When the quality of a loan deteriorates, the first signal comes as irregularity in
client’s loan repayment. Often a loan account starts having past dues. International best
practices require that a loan be classified as non-performing if its principal and/or interest
are three months or more in arrears. Banks in Bangladesh are allowed to classify non-
performing loans based on a time frame of three months. Early recognition of non-
performing loans stimulates collection efforts and helps reduce the possibility of loss of
such assets.

Loans may be termed as Non-Performing both from the objective and subjective
judgment. Objective criteria for loan classification are grossly set by Bangladesh Bank.
Subjective judgment by the bank officials are guided by the Instruction Circulars from
the top management.

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The following image shows the amount of NPLs at the end of June, 2020.

Figure 01: NPLs at the end of June, 2020 in Bangladesh

3. Bad Debt situation from the context of Bangladesh

Though the Money Loan Court Act, 2003 relating to recovery of defaulted bank loans
seems to be very commanding, in practice, however, the system is very ineffective. The
byways and loopholes in the system leave money loan cases of banks pending in the
lower courts year after year.

The Bangladesh Bank (BB) has started preparing a consolidated statement of non-
performing loans (NPLs) covering both domestic and offshore banking units from the
final quarter of the last calendar year.

According to the BB statistics, a total of 62,204 cases were pending with the Money Loan
Courts until June 2019 involving funds worth Tk 1176.14 billion. The share of NPLs in
the total outstanding loans came down to 7 66 per cent as of December 31 in 2020 from
8.89 per cent a year before, according to a consolidated statement of such loans. On the
other hand, the share of classified loans in the total outstanding loans came down to 8.06
per cent as of December 31 in 2020 from 9 32 per cent in the same period.

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The classified loans cover substandard, doubtful and bad/loss portions of total
outstanding credit, which reached Tk 11587.75 billion as of December 31, 2020 on a
consolidated basis. The latest BB data showed the amount of NPLs fell by more than 6.0
per cent or Tk 60.49 billion to Tk 882 82 billion excluding offshore banking operations as
of December 31 from Tk 943.31 billion a year ago.

Bangladesh Bank provides fresh loans have also contributed to squeezing the volume of
NPLs in 2020.

The volume of defaulted loans with six state-owned commercial banks came down to Tk
422.74 billion, excluding offshore banking operations, in the final quarter of 2020 from
Tk 439.94 billion a year before.

On the other hand, the volume of NPLs with 42 private commercial banks fell to Tk
399.16 billion as of December 31 from Tk 4417.74 billion in the Q4 of 2019.

The classified loans of nine foreign commercial banks came down to Tk 20.32 billion in
Q4 of 2020 from Tk 21.04 billion a year before.

However, the classified loans with two development finance institutions remained
unchanged at Tk 40.62 billion as of December 31 last year.

4. Reason of taking legal measures for credit recovery

Banks will put in place systems to ensure that management is kept advised on a regular
basis on all developments in the recovery process. The following issues shall be
addressed while conduction credit recovery functions:

 Determine Account Action Plan/Recovery Strategy

 Pursue all options to maximize recovery, including placing customers into

receivership or liquidation as appropriate.

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  Ensure adequate and timely loan loss provisions are made based on actual
and expected losses.

 Regular review of non performing or worse accounts

4.1 Recovery Steps of Credit

There are 2 (two) methods of loan recovery

I. Non-legal/non-judicial route
II. Judicial/legal process

Banks will first go through the non-legal measures to recover the loans. If a borrower
fails to make repayment of the dues the bank has to consider what steps need to be taken
to recover the debt. Banker will eventually have to take the following procedures to
recover the stuck up advances.

a) Existing loans (all categories):

 Diarizing due dates of repayment.

 Regular follow-up.

 Periodical inspection.

 Surprise visits.

b) Overdue loans/advances:

 Preparation of quarterly lists: Branch copy, controlling office copy and head
office copy.

 Attempts made for adjustment of loans before application of quarterly interest.

 Must be adjusted before being classified.

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c) Classified loans/advances (Substandard, doubtful and bad.):

 Targets for recovery.

 Steps for classification.

d) Interest exemption:

 Quick decision.

 Communication of decision quickly.

 4.2 Remedial Measures of Loan Recovery

 Ascertain reasons for non-payment.

 Persuasion

 Negotiation

 Training and motivating of staff.

 Classification of Borrowers to A, B, C & D.

 Manager handles “D” type customers

 Tailor-made strategies for different problems must be prescribed.

 Timely wisdom alone works as timely strategy.

 Recovery often proves   effective   when   follow-up   done   with   co-

obligates.

 Old loans cleared to secure new loans to be taken advantage.

 Clean loans not recovered are regularized by taking some sort of security to
have some hold on borrowers.

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  Legal review of documents & situation.

 Workout strategy & action

 Loss evaluation versus security cover

 Stay or leave decision & reclassification

 Continuous visits to the client (Defaulter)

 Negotiation versus court action

 Legal expenses multiplying

 Obtain support- senior management, legal counsel and specialist; legal,

business, and government.

5. Legal procedures
The purpose of legal action is to encourage the debtor to pay. If the debtor pays at
any stage during the process, legal action can be stopped. If the debtor refuses to
pay, legal action will continue until the debt and costs are paid in full or the debtor
makes a settlement. Where a debtor fails to pay, the court will grant judgment in
favor of the creditor. The banks file suit against the defaulting borrowers in
competent courts of law through banks approved lawyers to ensure recovery through
legal course of action:

 Recovery of loans through sale of mortgaged property or taking over management

of the defaulting concern.

 Filing money suit cases under Artha Rin Adalat Ain, 2003.

 Filing criminal case under Negotiable Instrument Act, 1881

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Procedures to be followed for filing and running cases under Artha Rin Adalat Ain, 2003:

5.1 Serving Notices

The debtor must always be made aware of the debt and be advised of any impending
action by a creditor. For this reason, the first step in a typical debt recovery action is the
issue of a letter before action (LBA).

The LBA will state that the debtor is on notice of a claim for a debt, that it must be paid
within a specified time frame, usually seven days and that failure to do so will result in
the issue of legal proceedings without further notice to the debtor. It further warns that
costs will be claimed if legal action becomes necessary.

The letter in itself is often all that is required to make the debtor appreciate the error of
his ways and pay up.

5.2 Serving Legal Notices

If the debtor fails to respond to the LBA within the time allowed, Court proceedings are
issued and served. Great importance is attached to issuing the proceedings seven days
after the LBA. This is to maintain momentum and to ensure that the debtor knows how
serious the matter is.

Issuing court proceedings is the process whereby the appropriate endorsement of claim is
drafted, the summons stamped with the required stamp duty and is submitted to the
relevant courts office for the allocation of a record number.

Once these matters have been attended to, the proceedings can then be served on the
debtor.

5.3 Serving Notice to the Guarantor

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Any third party mortgagors or third party guarantors involved with the loan, if there is
any, are to be made as opposite parties/defendants of the plaint along with the principal
debtor (section 6(5) of ARAA)

5.4 Assessment and Identification of Securities in respect of nature,

quality and Valuation etc.

The contents to be included within the written statement and the relevant formalities to
be followed are mentioned in section 8 of the ARAA. The written statement has to be
submitted within 40 days after the defendant first appears in the court in order to answer
the summon (section 11(1) of ARAA).

If the plaintiff wants to give an additional written statement in reply to the written
statement of the defendant then he has to file it within 15 days of the filing of the written
statement by the defendant

5.5 Attachment of other properties (if necessary) along with the

properties of Guarantor

If any property is given in mortgage or pledge or lien then before filing the plaint the
financial institution has to sell the property and adjust the loan or has to fail after trying
to sell the property. Please note that the financial institution has to have the lawful right
or been given the right to sell the property [section 12 (1) and (3) of ARAA]. If the
plaint has already been filed without the property being sold, then the plaintiff has to
sell the property and adjust the loan and inform the court in written form [12(2) of
ARAA].

5.6 Filing suits in the appropriate court for recovery of outstanding

loan balance

If the letter of demand proves unsuccessful or the parties cannot reach a common
agreement on payment terms, we can then file a claim with the appropriate court. The
amount and type of claim will depend on the route taken.

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6. Constraints of Recovery

 Exemption of interest by the bank/Govt.

 Exemption of loan including interest by the Govt.

 Political pressure and misunderstanding etc.

 Interest waiving & rescheduling culture.

 Natural calamity.

7. Recommendation for Improving Recovery Steps

 Steps for removing probable hindrances for recovery.

 Developing proper MIS.

 Coordinating efforts of concerned bodies/authorities.

 Developing banker-customer relationship.

 Support from Govt. and other authorities/agencies

 Developing monitoring & supervision techniques

 Accountability at all levels concerned

 Changing attitude of managers/officers.

 Allowing some more incentives for recovery

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  Reducing interest waiving and rescheduling culture

 Rehabilitation of sick/problem project, if possible

8. Conclusion

In Bangladesh, the concept of out of court settlement is not new Man establishments or
individuals do resort to such settlements. However, some tactically opt out for going into
settlement out of court so that the trial process runs for year after year, prolonging the
process deliberately.

In such circumstances, the legal procedure must be revisited considering all the aspects of
practicality such as the duration of suit/case, locating the persons within the duration of
suit/case, and further strict punishment. Immediate provision of arrest could be
introduced in enacting special law including establishment of debt recovery agencies in a
legal framework for the recovery of debts of banks. This is an important issue that needs
to be addressed especially for the businesses to run smoothly in the country.

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 References

1. https://www.legal500.com/developments/thought-leadership/non-performing-
loan-recovery

2. https://barristermunim.wordpress.com/2012/06/14/laws-of-bangladesh-part-1-
artha-rin-adalat-ain-2003-issue-i-scope-and-procedures/

3. https://theprint.in/economy/bangladeshi-banks-are-struggling-with-a-bad-debt-
problem-it-only-threatens-to-get-worse/280843/

4. https://www.thedailystar.net/business/news/recovery-loan-write-plummets-
1977681

5. https://www.scribd.com/doc/129094036/Credit-Recovery-Management

6. https://core.ac.uk/download/pdf/159583408.pdf

7. https://uniprojectmaterials.com/accounting/debt-recovery-techniques-in-the-
banking-sectors-issues-problems-and-prospects-a-case-study-of-union-bank-nig-
plc/project-topics-materials-for-final-year-students

8. http://erepository.uonbi.ac.ke/handle/11295/59692

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