The recent Supreme Court observations on loan write-offs is another welcome development in re-establishment of rule of law and accountability of those robber barons who defrauded banks and unjustly benefited from state largesse. The main beneficiaries of the loan write-offs programme, over a 20-year period, were fifteen hundred or so well connected political and business elite that benefited at the expense of the taxpayers and the poor.
Loan write-offs are a normal risk of the banking business all over the world. Loans are written off when borrowers cannot pay because of natural disasters, war, economic crisis, or simply bad investment decisions. Banks incur losses when loans are written off. When banks are government-owned, the government has to bear the loss and inject taxpayers’ money into the banks to keep them solvent. Thus, in Pakistan’s case, when the banks wrote off about Rs150 billion of bad debts, the government had to inject over Rs110 billion into the banks to prevent them from collapsing.
The genesis of Pakistan’s high level of bad loans was the poor governance and deep politicisation of the government-owned banking system, during the 20 years starting the early 1980s. Through collusion between bankers and borrowers, banks were “raided” by the high and mighty who borrowed imprudently, knowing fully well they would not be able to pay back nor be subject to any criminal wrongdoing. Thus, by the end of 1990s, the banking system was on the verge of collapse resulting from huge losses due to very high levels of non-performing loans. Consequently, the government had to inject over Rs110 billion of new capital which, along with other banking-sector reforms, including privatisation, enabled the banking system to achieve stability and soundness.
Many countries have used taxes to support loan write-off programmes for small farmers and small borrower. For example, during the recent financial crisis, the UK government provided support to small borrowers (loans under $20,000), and the US had a programme to restructure home mortgages for low-income families, while tens of thousands of richer families had to sell their expensive homes to avoid defaulting on their mortgages. In Pakistan’s case, the government would be fully justified to use taxes for financing loan write-off for businesses destroyed in the 2005 earthquake or as a result of terrorist attacks. However, there are very few examples of a generous loan write-offs programme for the rich borrowers, such as that pursued by Pakistan.
In case of large borrowers, no serious effort was made to distinguish between defaults resulting from genuine difficulties (i.e., a natural disaster, an economic downturn) or from excessive borrowing and the owners’ siphoning-off company funds for personal use. The banks should have undertaken a rigorous review to assess whether the rich and large borrowers made any serious effort to raise money to pay-off loans and inject new funds into their financially troubled companies – such as, selling their personal assets including luxurious homes, luxury cars and jewellery, making their children study in Pakistan rather than overseas, leading a simpler life expected of a bankrupt person, etc. In the absence of such a review, there was no real hardships imposed on large wilful defaulters and scarce tax revenues were used to bail out poorly performing companies with rich owners.
For large borrowers, instead of writing off the loans, the banks should have pursued the option of converting the loans into equity which would have provided some possibility of the banks recovering their money when the companies became profitable. Also banks did not require change of ownership or management. In most countries with higher accountability standards, when banks restructure or write-off loans, existing owners and/or existing company management is changed. Consequently, in Pakistan, losses were socialised, while gains were privatised.
The policy to let large and wilful defaulters off the hook was not subject to serious public debate or public scrutiny. The Rs100 billion or so of loan write-offs for around 1,500 large borrowers was essentially a gift from the taxpayers to these rich folks. In most countries, other than those where there is high degree of accountability and public scrutiny on the use of taxpayers’ money, politicians and bureaucrats do not treat public money with the same degree of financial prudence as their own money. Since there was no rigorous public scrutiny and funds were not coming from the pockets of the decision-makers — whether the president, the prime minister, the finance minister, or the SBP governor — they were all too willing to provide a “subsidy” of Rs100 billion to rich robber barons. This subsidy exceeded the entire annual education budget of Pakistan during the period that the programme was implemented. Moreover, future generations have been saddled with over $1 billion of external debt, which was borrowed to pay for the programme.
Importantly, write-offs are discriminatory and inequitable. They benefit the inefficient and wilful defaulters, giving them a competitive advantage over the good borrowers, whose operating costs becomes higher than those of defaulters when the latter’s debt service is written off. The government justified write-offs to revive growth. However, there is no credible evidence to indicate that write-offs indeed increased growth. The Musharraf government was desperate for legitimacy, and this imprudent largesse of tax money was a convenient way to “buy” the support of big businessmen.
Revisiting this matter and recouping written-off loans for all write-off beneficiaries from 1971 to 2009, will be an almost impossible challenge — considering the long elapsed time and difficulties in retrieving records and revisiting history. However, a selective approach targeting the large defaulters may hold the promise of recovering some of the taxpayers’ monies. The Supreme Court may wish to consider establishing a “Blue Ribbon” Committee – headed by an eminent banker with high integrity and comprising forensic auditors, lawyers, etc — to review loan write-off cases of the top, say 500, defaulters and all those (and their immediate family members) who are currently holding public offices and in leadership positions in political parties.
The committee would be tasked to determine, within three-four months, the following: (i) whether fraudulent and collusive means were used to obtain the loans in the first place, and whether companies were used to enrich owners at the expense of the banks; (ii) the reasons for the default and whether there were adequate “public interest” reasons to let the borrowers off the hook; (iii) how much of the written-off amount can be collected now – either in cash or shares of the company — considering the current wealth and income levels of the beneficiaries, and profitability of the companies.
As part of its review, the Supreme Court may consider invoking the appropriate laws to debar from holding public office all those (including their immediate families) who are unable to fully pay back their written-off loans within 60 days. This action, along with the above targeted approach, would: (i) send a clear signal to large and politically well connected borrowers that they have to not only treat bank loans with responsibility but also return taxpayers’ funds wrongly provided to them; (ii) convey an unambiguous message to politicians and their immediate families that rule of law equally applies to them, thereby strengthening democracy; (iii) establish a precedence to curb future policymakers from using taxpayers monies imprudently; (iv) assure taxpayers that wasteful use of tax monies to benefit the few, at the expense of the many, will be scrutinised by the court. Overall, recovering unjustified written-off loans would strengthen good governance as well as the banking system.