Bad, But Not That Bad

by Steven van Groningen on 21 July, 2010

Sometimes people try to make things look better than they are. Breast implants, leasing Rolls Royces- I understand there are still a few repossessed ones for sale – statistics and politicians come to mind.

Sometimes people try to make look things worse than they are. Doom sayers, former bankers that like to be quoted again and politicians come to mind.

Often this is discounted by a healthy dose of skepticism. My father was and a good example, he used to say about a certain politician that when his lips were moving he knew the man was lying.

This is however not always the case and some people will believe things as presented. Too bad, it happens. Much worse is a situation in which things are presented worse than they are but the suspicion is that things are presented rosier than they are. This is exactly what happens with non-performing loans in Romania.

Non Performing Loan Levels Are Overstated in Romania

The latest example is the Financial Stability Report 19 by the National Banks of Austria. It analyzed the levels of non performing loans in SECEE countries. Romania came out as the worst but one (only Ukraine was worse).

This was commented upon in the press ( without mentioning the small print that data are not comparable across countries, but that is another story)

For the casual reader this looks pretty bad. However, every professional in Romania knows that the official figures are drawn up according to Romanian Accounting Standards. These local standards (RAS) have two features that inflate non performing loan figures in comparison to international practice.

Romanian Accounting Standards Inflate Non Performing Loan Levels

The first is that in Romania banks are not allowed to write off loans unless all legal means have been exhausted. This means that, even though the possibilities to recover the amount are minimal and the costs of the recovery efforts are above the amount that will be recovered, banks may not write off the – already provisioned – amount as loss. As a result, in comparison with other countries where banks write loans off after 180 days past due, Romanian non performing loans  percentages are higher. This is a bit like reporting a dead patient  in a hospital as just ill, because the death certificate may not be signed yet.

The second difference is that banks have to accrue interest on loans that are non-performing. If a customer has not been repaying the loan for more than – say – 180 days, then it is rather unlikely that he will pay the future interest. For that reason international practice is to stop accruing interest after 180 days past due. In Romanian Accounting Standards this is not allowed, so banks book interest income and – because they will most likely never receive the amount  – create immediately a provision for the same amount . It will be no surprise that this increases loan loss provisions. Why recognize something as income and simultaneously provision it 100% ? Better not to book it at all.

By the way, writing off or not accruing of interest doesn’t mean that banks will not occasionally recover amounts that have been written off, including interest that is not accrued for. Accounting doesn’t change the legal relationship.

Also, not writing off provisioned loans doesn’t affect the profit or loss of a bank. The loss is already provisioned.

Banks Use International Standards Anyway

So, the question is, why are we (still) doing this in Romania? Banks have been asking for this to be changed for a long time. Not only because it makes them look worse in comparison with banks in other countries which creates the need to point out all the time that things in Romania are not as bad as they seem. The second part is that banks in Romania also prepare their financials according to International Financial Reporting Standards (IFRS) anyway. Because banks abroad don’t understand RAS, they ask for IFRS financial reports before entering in business relationships. So the RAS reports are just more work for banks in Romania.

Romania need a lower country risk premium

This is not something that is only of interest for banks. When analyzing a country, indicators like non performing loans are an important indicator to assess the economical situation of a country. Showing higher levels of NPLs in comparison with other countries will impact the so called country risk premium. Higher country risk means higher financing costs. This is very important when you have a big budget deficit to finance. The Romanian state needs to finance billions. Even a minimal improvement  in rates saves millions.  So, here we have a measure we can take that doesn’t cost any money and will save us money. Why not take it ? There is no need to try to present the situation any better than it is, but worse ??

{ 6 comments… read them below or add one }

Leslie Hawke July 22, 2010 at 10:46

Very interesting! Can you now explain why/if the 24% TVA is bad, but not that bad?


SvG July 22, 2010 at 17:42

No, I can’t because here the question is how bad it will be. Nobody can answer that question. It will be bad for sure from more points of view, higher prices, inflation. What is unknown is how the increase will be passed on to the population. Here we can only hope that only part of the increase will be passed on and the remaining part will be paid for by the companies out of their margins, at least for some time. What is clear is that it will further impact consumer confidence and consumption will decline further.


jhuitz July 23, 2010 at 09:07

Excellent points. Coming from an American bank to Romania, it took me some time to understand that there was no concept of nonaccrual. Banks do produce IFRS figures, but it seems to me that they operate using RAS only, that’s what staff on the ground use, they themselves do not understand or care about IFRS. (Banks, at least some, produce RAS figures and reconilce to IFRS in the process making the latter meaningless in terms of scope of detail.)

I generally agree with you on your points, but I also find what seems to be the common practice of repeated restructuring and activations is basically flogging a dead horse and denying the obvious. I suspect that this practice alone materailly deemphasizes the scale of real nonperforming loans. In short, ‘loss recognition’ becomes an oxymoron. As for nonaccrual, I truly wonder how much of bank reported revenue is real, how much will actuall become cold hard cash.

My conclusion then is that there are too many hole and little clarity. So, I will just assume the worst.


SvG July 23, 2010 at 10:34

Indeed, people assume that the number will be understated for the reasons you mention, while in fact the published RAS numbers are overstated based on methodology. In Romania we are maybe in a position to use judgement about the real situation, for the rest of the world this is very difficult and they might assume that even RAS is overstated. Indeed some banks are flogging dead horses, others know the horse is dead buy may not bury it until they have proven they tried to revive it by force feeding sugar cubes once a day for 90 days or so.


Oliver Olson July 23, 2010 at 18:50

Thanks for the informative post. This is a perfect example of the concept that we espouse at the CEU Business School and now the Maastricht School of Management Romania… namely, doing business in Romania is not the same as doing business anywhere else. This is the type of local context that a business leader needs to be aware of… or at least needs to know to be on the lookout for.


Paul Dinescu September 2, 2010 at 22:21

Steven I think that NBR had a word to say on this issue when it first arised, meaning they wanted to be overprotective to the extreme and get a worst case scenario picture of a system that was just becoming functional (i.e the banking system). That was valid in a period when RAS nonperforming assets were very low both corporate and consumer (because economy was much smaller, consumer credit almost non-existent, country rating bad anyway, lending to state entities much smaller than today etc). Now this is working against the system because is blocking so much cash in the balance sheet of banks, but they are afraid to adapt. Totally I agree with you that RAS is working against the system. “Rubber stamp syndrom” is present here as well.


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