Banking on uncertainty

The growth of the banking sector in the past decade and the increasingly smarter services
provided by quite a number of banks to their clients have overshadowed the reports of
lacklustre banking and default loans of the 1980s and the 1990s. In fact, the new generation
banks have attracted the country’s one of the biggest pools of educated workforce. Many of
them have shown magical uptrends of earning profit at a time when banks in developed
countries struggled as reflected in the events of global economic meltdown.

Encouraged by the magic boom in banks and banking services in Bangladesh, new banks
joined the market. The ‘generous’ policy of successive governments raised the number of
banks above 50. Such banks, the private commercial banks (PCBs) in particular, saw growth
in operating profit in a range between 30 and 95% in the first half of 2012. As many as 27
PCBs recorded more than Tk 6,500 crore operating profit, which though did not indicate the
actual financial position of each bank.

Then came to the limelight, perhaps suddenly and surprisingly, the Hall-Mark scandal with
an involvement of Tk 4,000 crore that jolted the entire banking sector. It reminded all that
the dream of saying goodbye to the era of bad loans through proper analysis of risks and of
practicing ethical banking remains elusive to a large extent. The scam also raised questions
about the health of the overall banking sector and effectiveness of the regulatory system
now in place.

Against such a backdrop, how strong or weak do we think are the banks that are operating
in a growing economy like Bangladesh with a rising consumer class? Are there any flaws
with the banks’ magic show or what does go wrong in the magic? Will the banks be able to
cash in on the potential of increasing monetisation, expanding businesses and
industrialisation and demand of foreign exchange earners and domestic clients? What are
the challenges that banks will have to face in the days to come?

Insulated from recession

Bangladeshi banks, especially the private ones, remained almost immune to the impact of
the global slowdown in 2007-08. The busting of bubble in America’s housing market caused
a devastating blow to the US economy and its effects spilt over all over the world. The
Bangladeshi banks had though witnessed a decline in demand for loans used in imports of
goods; they managed to continue to make profit coming from other sectors, thanks also to
their lesser exposure to the international financial market.

The banks’ profit comes mostly from interest on loans and value addition from investments.
But banks in Bangladesh were often encountered with problem of realising the money
distributed as loans. When loans are allocated on political considerations, banks just fail to
ensure payment of interest – reality that has been reflected in the waiver of interests by
bank boards time and again. Such practice resulted in declining profitability of banks. To
overcome the situation, the banks had shifted their focus since 2003 to products other than
excessive dependence on income from interests of loans.

Accordingly, the banks started earning from service charge. The private commercial banks
are currently making profit by taking various kinds of service charge for delivery of services
to the clients. The state-owned banks, too, later joined the spree of applying service charge.
Also, sales and purchase of foreign currencies have been a major source of their earning.

Banks are also earning from the transactions of remittances that have emerged as a major
source of their income.

Scamming the system

The Hall-Mark scam has exposed the remaining weaknesses in the banking sector,
reminding the people the state of state-owned banks which were previously called
nationalised commercial banks (NCBs). As a matter of fact, the process of manipulation and
politicisation of banks began immediately after independence. The NCBs were being
plagued by the burden of losses. The losses were caused mostly by political interference and
tendency to loot public money rather than for business reasons. A section of powerful
people managed to ensure disbursement of loans against their names by using their political
influence. The loans in most cases were never repaid. As a result, the volume of default
loans swelled over the years. Banks were burdened with the accumulation of a huge
outstanding loans, especially nonperforming loans.

Former governor of Bangladesh Bank Dr. Salehuddin Ahmed termed the mis-governance or
lack of proper regulation in the banks and financial institutions an infectious disease, a
problem, which, he cautioned, might spread fast and affect the entire sector. Hall-Mark
Group and a few other organisations took money from banks, financial institutions and also
from the public since, he argued, the financial sector proved to be broadly unregulated.
Non-performing loans of the banks were still on rise, added Dr Salehuddin. His predecessor
Dr Mohammad Farashuddin blamed a lack of proactive behaviour of the regulator for such a
situation. He even described certain profit made by a section of private banks as fake one
aimed at appeasing the shareholders.

Their statements could be substantiated if we check the latest figure of default loans, which
rose by more than Tk 7,000 crore in a span of three months in 2012.

Number of banks on rise

There is no stopping of increase in the number of banks or in other words Bangladesh has
continued to see opening up of new banks. These banks were given licence, not merely to
meet the market demand, but mainly on political considerations. Setting up of banks by the
use of political influence of the entrepreneurs has already caused negative effects in the
banking sector as a whole. The fallouts have been reflected in the recent ineffectiveness of
the central bank’s authority and regulation required for a healthy functioning of the
commercial banks.
Despite note of dissent as a manifestation of objection, politically influential people were
given permission for opening nine more new banks. The Finance Minister, AMA Muhith,
reportedly said then that this might be the last time the government would give permission
for new banks on political consideration. Apart from the central bank’s reservation, the
country’s economists and bankers almost unanimously said there is no necessity of new
banks as the national economy with its current size and dynamics would not be able to
absorb so many banks. Instead, they suggested that the Bangladesh Bank should tighten its
grip of regulation on the existing banks. The issue of issuance of licence for nine new banks
is now at the final stage of the central bank’s approval.

The banks in Bangladesh had serious shortage of liquidity after the independence. In order
to raise the flow of deposit, the government took initiatives and a special savings scheme
titled ‘deposit pension scheme’ was introduced to improve the banks’ liquidity situation.
The scheme with various terms – five, 10, 15 and 20 years – offered interest rate between
16 and 18%. At that time, the bank rate, the one the central bank offers the commercial
banks for providing loans, was 10-12%. The interest rate applicable for general savings
accounts was around 10%and at the same time, the interest on loan was also higher.

In the banking sector, the rate of interest on loans and deposits largely depends on the bank
rate, which was about 11% during the Ershad regime. Once the banking sector embraced
better discipline the bank rate started coming down and the latest bank rate stands at 5.5%.
The highest interest rate has been 13% and average interest rate on loans 12% with the
highest range up to 17%.

The central bank has meanwhile fixed the ‘spread’ – the gap between interest rate on bank
loans and deposits – at 5% maximum. According to the rule, a bank could charge 5% higher
interest on loan recipients than the interest payable to depositors. The money to be
accumulated through the surplus five percent interest should be spent on meeting the costs
of the bank’s own expenses including staff salary.

Not performing

In June 2017 the government allocated Tk20bn (US$250m) to recapitalise Bangladesh’s

state-owned banks. There are signs that the country’s banking sector is facing mounting
problems, and regulators’ efforts have so far been insufficient to tackle the issue. Only
limited action has been taken to penalise defaulters, improve risk management and
strengthen bank management.

In its latest Article IV report, the IMF stated that there are some underlying risks to the
banking sector in Bangladesh owing to excess liquidity. However, an improvement in
conditions within the state-owned banking sector will be dependent on the political will to
address the problem, which has been limited so far.

In its report, the IMF said that there were weaknesses in the banking sector owing largely to
the legacy of loans to large borrowers, who lack incentives to repay, and legal limitations
that hamper recoveries. Six state-owned commercial banks account for about a quarter of
total banking sector assets. They are supplemented by two state-owned specialised
development banks, 40 private commercial banks and nine foreign banks.

The eight state-owned commercial and specialised banks suffer from problems related to
high levels of non-performing loans (NPLs), low profitability, large capital shortfalls and
balance sheet weaknesses. The root of the problem is poor risk management. For decades,
state-owned banks have lent large amounts to big, influential borrowers, who have been
known to be lax with repayments. Defaulters are rarely penalised; instead, loans are
routinely restructured to permit further lending to the same borrowers. According to a
study by the Bangladesh Institute of Bank Management, on average banks rescheduled bad
loans of Tk109.1bn annually during 2010–14.

As a result of these issues, non-performing loans (NPLs) at state-owned banks have risen
sharply in recent years. In January-March 2017, overall, bad loans in the banking sector rose
by 18% from the previous quarter, to Tk734.1bn. NPLs at the six state-owned commercial
banks rose by 15.1% quarter on quarter, to Tk357.2bn, accounting for just under half of
total NPLs. It is possible that the problem may be larger than these numbers suggest.
Central bank inspections have found that several state-run and other commercial banks
have under-reported bad loans and inflated profits. For example, in the quarter ending
December 2016, four state-owned commercial banks under-reported Tk40.7bn in loan
defaults: Janata Bank, Agrani Bank, Rupali Bank and Sonali Bank.

Undermining capital

Unsurprisingly, these high NPLs have hit profitability hard. In 2016 the operating profits of
the six state-owned commercial banks dropped by 37% annually, to Tk20.1bn, while net
losses surged by 309%, to Tk5.1bn. Meanwhile, losses at the two state-owned specialised
banks (Krishi Bank and Rajshahi Krishi Unnayan Bank) rose by 150%, to Tk4.2bn. By contrast,
the net profits of the banking sector as a whole rose by 4.9% in 2016, while those of private
banks rose by 17.2%, according to a report by the Economist Intelligence Unit.

Over the past few years the government has provided large amounts to recapitalise banks.
According to data from the government’s finance division, between fiscal year 2011/12
(July–June) and 2016/17, the government has provided state-owned banks with a total of
Tk116.6bn in recapitalisation funds. From Tk3.41bn and Tk4.2bn in 2012/12 and 2013/14,
respectively, the allocation surged to Tk44.77bn and Tk26.17bn in each of the next two
years; this was followed by more modest amounts of Tk18bn and Tk20bn in the next two
years.

The decision to provide funding has been criticised, as it has been seen by some as the
government diverting taxpayers’ money away from needed investments in social sectors like
healthcare without putting the necessary measures in place for structural reforms. In a
March 2017 meeting the government’s finance division observed that, despite the regular
infusion of budget funds, state-run banks have not improved their NPL positions.
Meanwhile, reportedly, in the past two years BB did not recommend any capital infusion for
these banks to the finance ministry. In mid-2017 BB asked the state-owned banks to meet
shortfalls at their own initiative, such as by boosting business activities.
Despite this, in the budget for 2017/18 the government has again earmarked Tk20bn to
recapitalise state-owned banks, against the March 2017 capital shortfall of Tk147bn, with
the highest amount going to the scam-infested BASIC Bank (Tk10bn). The finance ministry
says that the funds will have conditions attached, such as not investing in risky ventures.
Meanwhile, in March 2017 three state-owned lenders were given preliminary approval to
raise up to US$510m to improve their financial health. BASIC Bank is considering issuing
government-guaranteed cashless bonds worth US$325m, while Janata Bank and Rupali Bank
will sell subordinated bonds. BB has repeatedly warned banks to improve their practices in
several meetings. In February 2017 the central bank governor termed the bad loan problem
at state lenders “alarming” and attributed it to banks favouring a few large companies,
pointing out that 40% of Janata Bank’s loans, for instance, have gone to just nine big
industrial groups.

Nevertheless, the regulatory response to the banking sector’s problems needs improving,
the EIU said, with little action taken so far to penalise defaulters, improve risk management
and strengthen bank management. Apart from the political influence of large borrowers,
regulators are concerned that too hard measures could force corporate bankruptcies,
raising unemployment. Since the six state-owned commercial banks employ almost 60,000
people and have 55% of branches in rural areas, regulators are also cautious about
measures that might destabilise these.

Regulatory measures to resolve NPLs have not been as successful as officials had hoped. For
instance, in 2015, after pressure from large borrowers, BB issued a more lenient
rescheduling policy for borrowers with loans exceeding Tk5bn. Thereafter, 20 companies
applied for the facility, and 11 industrial groups were allowed to reschedule loans worth
about Tk150bn. Repayment of the rescheduled loans was to begin in December 2016, but
many of the companies have made only partial or no repayments and are now asking for
further loans or rescheduling.

Regulators will need to make further efforts to tackle the sector’s deep-rooted problems of
corruption, poor risk practices and collusion with industry. As the IMF pointed out in its
report, an implicit government guarantee on their deposits keeps state-owned banks highly
liquid, but a further deterioration in their balance sheets could negatively impact the fiscal
balance. It suggests that banks should be held strictly accountable to numerical targets
agreed upon with the authorities and that reforms should focus on improving supervision,
containing risks from loan concentration and improving the legal and financial framework
for loan recovery. However, ultimately, any real clean-up of Bangladesh’s state-owned
banks will have to begin with political will, which appears to have been limited so far.

Bankers voice concern

Against this backdrop, it was revealed that some 72 percent bankers are in favour of
reducing the number of banks in Bangladesh through mergers or acquisitions as their
present number is too high given the size of the economy, according to a survey. About 88
percent of the respondents said mergers, acquisitions or takeovers may be executed to trim
the number of banks, particularly the weak ones, found the survey of the Bangladesh
Institute of Bank Management (BIBM).

As of June this year, total default loan stood at Tk 63,365 crore, accounting for 10.06
percent of the total loan outstanding. State-owned banks accounted for one-third of the
total sour loans.

About 77 percent of the respondents think a merger between two poorly governed banks
will not be successful in Bangladesh. According to the research, improving asset quality was
one of the prime motives behind the merger of Bangladesh Shilpa Bank and Bangladesh
Shilpa Rin Sangstha, but the result was not satisfactory.

The two state banks’ combined default ratio was 28.57 percent in 2009 when they merged
and started journey as Bangladesh Development Bank Ltd. BDBL’s non-performing loan ratio
stood at 46.18 percent in 2015.

In developed countries, the concept of merger is seen as an attempt to enhance profitability

and expand internationally, but in Bangladesh the perception is that weak banks merge, said
Khondkar Ibrahim Khaled, a former deputy governor of the central bank, at a recent seminar
organised by the BIBM where the findings were revealed. “As a result no merger became
successful in Bangladesh,” he said.

Khaled also said the excess number of banks will turn them into “grocery stores” soon.
Moreover, the new amendment to the Banking Companies Act to allow four members from
a single family to become directors of the board will bring disaster for the sector. He called
upon bankers to raise their voice against the amendment that the cabinet has already
approved.

The problem though, is that no one seems to be listening.