A good end to a bad idea

Published: March 20, 2011
The writer is a partner at Bhandari, Naqvi & Riaz and an advocate of the Supreme Court

The writer is a partner at Bhandari, Naqvi & Riaz and an advocate of the Supreme Court

The Supreme Court’s investigation into all loan write-offs since 1972, recently came to an end when the court announced that the question as to whether or not any write-offs were politically motivated would be examined by a three-member committee headed by Justice (retd) Saleem Akhtar.

The decision to khudday line the problem into a committee makes sense because the investigation into loan write-offs was, from the very beginning, a bad idea.

It was a bad idea, firstly, because this was not a task that the Supreme Court could handle. Over the past 40 years, there have been, not just thousands, but tens of thousands of cases in which banks have written off loans. Each loan write-off involved a factual judgment call made by the bank in question that there was no more blood to be wrung out of that particular stone. Is it possible that some of those write-offs were politically motivated? Absolutely! But how were you going to find those particular needles in a vast haystack of instances? Was the Supreme Court going to carry out a factual inquiry in each and every case to determine whether or not there were other properties which could have been sold? Was the Supreme Court going to carry out a cost-benefit analysis of each instance to determine whether or not the write-off was made for ‘mala fide’ reasons? If so, what about all the other issues and cases requiring court attention?

It was a bad idea, secondly, because there comes a point in time when we have to let bygones be bygones. Yes, we went through a period of time — essentially 1974 to 1994 — when, in many cases, political power was grossly abused for material gains. But trying to peek through the murky remnants of decades-old financial documents leads nowhere. These deals are now dead and buried. Interring their bones would do no good. If the companies which got the write-offs went on to prosper, the write-offs were worth it. And if they died notwithstanding their write-offs, then what further purpose would have been served by stretching their desiccated remains on the rack?

Let us also remember that we have already been down this particular road to nowhere. In 1999, some fool sold the NAB law to General Musharraf and a whole organisation devoted to tracking down fraudulent write-offs was born. Did it succeed? Short answer, no. That would be why the NAB law was amended to allow the State Bank of Pakistan to ride herd on the NAB cowboys.

In any event, the root of the problem was not the fact that loans got written off but the fact that the nationalisation of banks by Bhutto Sr. had put politicians in charge of the banking system. That original sin has now been fixed with the privatisation of the major banks (MCB and ABL in 1991, UBL in 2002 and HBL in 2004). So, if banks lose money on bad write-offs, it is no longer the government’s problem or even ‘the people’s’ problem: It is the bank’s problem, or more correctly, the bank’s shareholders’ problem.

The write-off hullaballoo was also a bad idea because it catered to the populist perception that an unpaid loan is a crime. Unfortunately, it is a cold, hard fact of nature that businesses make money by taking risks. Sometimes the risks work out well and sometimes they work out badly. But the reason why banks charge interest on loans — oops, pardon me, mark-up — is so that they make enough money from the good loans to cover the losses from the bad loans. Those losses are an inevitable fact of doing business. They are to be minimised, but they are necessary and unavoidable. If anything, it is our idiotic obsession with minimising default risk which makes doing business so problematic in this country.

Let me explain. Suppose you have identified a promising business opportunity. Like many entrepreneurs, you need to borrow money. But if you go to a bank, they will force you to back up the loan, not just with property, but with a personal guarantee. Which means that if you fail, you lose not just your investment but, quite literally, the shirt off your back. And, thanks to the NAB law, a default could land you in jail for 14 years, even if it occurs despite your best efforts! Now, tell me, how many risks would you be willing to take?

This is not a minor issue. A failure to allow risks in business is much the same as a failure to allow business. The single most important legal step in business history was the development of the limited liability company. The reason is that this development let people put a cap on their risks, so that if the business went belly-up, the investors lost the value of their investments, but no more. This in turn produced a flood of investment which in turn led to, in aggregate and over time, far greater prosperity for all. In Pakistan, we have effectively destroyed the concept of limited liability and the consequences of that are evident for all to see.

The final point is that there is no cosmic unfairness in the fact that small defaulters get no respite from bad loans while big defaulters are able to finagle deals: That is inherent in the nature of business. To paraphrase Keynes, if you owe the bank a thousand dollars, you have a problem. But if you owe the bank a billion dollars, then the bank has a problem. Yes, from the perspective of the small defaulter, that sucks. But, to repeat, that’s business. Get over it. Or come back when you have figured out how to rewrite the laws of finance.


The views presented are not those of his firm

Published in The Express Tribune, March 20th, 2011.

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Reader Comments (9)

  • Uza Syed
    Mar 20, 2011 - 3:09AM

    This is good —— Naqvi Sahabjee, send a few copies of this to all our self-admiring, ignorant (at least matters relating to ‘Money & Banking’ and bsic Economics) the chronic agitators in politics and media and, yes, to the mandarins in that august house with a ‘Balance’ tilting towards popularism (it’ll be nice if translated in Urdu language of about class sixth standard!).Recommend

  • John
    Mar 20, 2011 - 8:49AM

    Well said. State should stay away from Business, and judiciary certainly has no knowledge or skill to determine if the loan write off was politically motivated or business related.

    However, the reason for the inquiry is politically motivated. As such no matter how much Keynesian philosophy is discussed, it will continue.Recommend

  • White Russian
    Mar 20, 2011 - 9:48AM

    Hi Feisel, Excellent write. In our country catching a thief is not just catching the thief, but has an exalted aim of attaining certain spiritual kind of purity. Normally, when you fail, it makes sense to put an end to the matter, and look forward. But no, Musharaf’s failure with his NAB, and earlier that of Accountability Bur of Sharif Brothers, can not intimidate our dogmatic purists from yet again trying the same old pill.Recommend

  • ArifQ
    Mar 20, 2011 - 1:17PM

    According to the writer, if a person is being raped its better that they lie back and enjoy it cause hey nothing good will happen if you seek justice against the high and mighty.

    I am not sure which banking experience if any Mr. Naqvi refers too, but lending is not restricted to “Guarantees”, bank lending can take many shapes as per contractual requirements some examples could be “Collateral”, “working capital”, “Lien over goods”, “personal Capital” and most importantly “Reputation”. There is a famous saying in Banking, Bankers have to determine not just the ability but also the willingness to return, this is where politically motivated loans destroyed the basic fibre of prudent lending standards.

    Politically motivated loans was made an art form by Zia Ul Haq and his cronies who raped and pillaged Government owned banks, its easy to sit back and claim banks have been privatized therefore no point in excavating these dead and buried skeletons, I beg to differ. Those politically motivated loans that were later on written off for 10% of their original value is outright corruption and to ignore it would be tantamount to legalizing corruption, if we are to authorize those corrupt practices then what is the problem with NRO? Basic principle is the same.

    We in Pakistan conviniently brush everything controversial under the carpet or in someone elses backyard, its about time we engaged our past and atoned for our sins may it be East Pakistan or loan scandals. Recommend

  • Sarjeel Mowahid
    Mar 20, 2011 - 2:39PM

    You see the judiciary`s attempt while a useless and impossible task to you has proved to be effective in the Hamesh Khan Case. The natural outcome was the belief if they tried they could get money back when it was sanctioned under government pressure by those in power to either their own companies or companies owned by their relatives and later written-off.

    You want an example of political pressure on pvt banks follow the MCB case regarding deposit of shares in CDC in Lahore High Court its all abt that.

    My point is your cost benefit analysis of what is good and bad though may be the practical solution but surely you know the SC is not talking abt credit card loans written off or small loans. Oh and FYI be it a pvt bank or public bank it should be your “concern” since a hard working Pakistani`s money is lying in that bank…As for the banks being more diligent well would you say no to politicans who lietrally frames policies of the country think abt it.

    But I think this is a useless debate like you said mamla kudday line hogaya hai Recommend

  • Masood
    Mar 21, 2011 - 12:22AM

    Your explanation of finance and risk is logical and academically perfect, but you have overlooked the basic reason for the hullaballoo behind the defaulters and their defaults. If the defaulter had defaulted due to risky business, no pun intended, then it is easy to accept, but the huge defaults came from politicians and other leading figures of the society taking the “loans” for businesses they never intended to have. The bankers and accountants took their 10% of the loan, no pun intended there either but the analogy might be apt, and then the business was shown to have failed and everyone walked off with the money in their pockets. The only loser is the depositor. Surely those defaulters can be identified? But who is going to identify them? The very people who are supposed to monitor the fairness in the process are the culprits, the bankers, the government bureaucrats, the politicians, the generals.
    If Musharraf had allowed the NAB to put the ex-generals behind bars then the process might have yielded something, without which it would be a political witch hunt and doomed at the start. No need to blame Zia for it, it had been in practice long before that.
    By the way, who are these corruptors of our pure society? The amry, the police, the bureaucracy, the judiciary etc. are not aliens from Mars, they are the mammas chachas tayas cousins and friends of the educated elite who have had the resources and the education to read this paper in English.Recommend

  • Feisal Naqvi
    Mar 21, 2011 - 8:58AM

    @Masood — identifying willful defaulters is (a) difficult; and, (b) very very time consuming. I did a bunch of NAB cases when the law first came out. And without exception, all the loan default cases were incredibly stupid. I actually cannot think of a single case in which a fair judge would have convicted. More importantly, almost all of the cases resulted in eventual acquittals (at least the high profile ones).

    Assuming it was theoretically possible to identify willful defaulters, I would have no problems sending them to jail. But fraud convictions are very difficult to obtain in practical terms, given our judicial system. The two practical options are (a) punish all default as if it were willful or (b) for the most part, ignore the problem. In Pakistan, we have done both. The NAB law defines all default of more than 30 days as willful but now nobody ever gets prosecuted under the NAB law. So, we have the worst of both worlds.Recommend

  • Masood
    Mar 22, 2011 - 8:13PM

    I agree with you Feisal, that is why I alluded to the connivance of the bureaucracy who are supposed to keep the checks and balances and oversee the transparency of the transactions. These middlemen, the accountants who prepare the business plans, the bankers who lend the money and the government arm that is supposed to ensure financial fidelity, are the ones who skim the money, take their cut, and make sure that the fraud or robbery is buried under procedural haystack. Given the connections of these people with all the power brokers, it is in no one’s interest to really track them.

    You wrote a very good article to articulate our helplessness and that the only way left is to move on.Recommend

  • Akbar
    Apr 17, 2011 - 10:23PM

    List item

    No doubt loans particularly big loans have political influence and underhand dealings too with the management but but stepping into the system by judiciary as done should have been avoided but as well seen that nothing came out. Similar situation was seen in sugar issue. The system and the law has to re-modified and amended in such a manner that mortgage properties be tailored by banks and out of proceeds some percentage be paid to customer and out of remaining loan be recovered. After finalizing amount property be redeemedRecommend

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