Bangladesh’s phenomenal economic growth is obscuring the fact that parts of its banking sector are suffering with persistent NPLs – with little evidence that repeat offenders will be penalised. Jason Mitchell reports.

Standard Chartered Bangladesh

Bangladesh has a total of 57 banks yet 10 state-owned commercial banks (SOCBs) account for about 28% of total assets in the country, according to the central bank, Bangladesh Bank. Now some of these SOCBs are essentially insolvent, and are threatening the stability of the banking system – despite the country's economy being the third fastest growing in the world. 

The banking system’s biggest issue is the deterioration in asset quality over the past few years. The overall non-performing loan (NPL) ratio jumped to 11.9% in March 2019, up from 9.3% at the end of 2017, according to the central bank. The SOCBs had an NPL ratio of about 30% at the end of 2018, and accounted for more than half (52%) of total default loans in the industry.

However, experts say the official NPL ratio underestimates the problem. There has been a growing trend of loan rescheduling and restructuring, including those granted by Bangladesh Bank on an individual basis – although it requires banks to keep provisioning for these loans, according to an International Monetary Fund (IMF) report published in September 2019. 

The total ratio of rescheduled and restructured advances to total advances increased to 10.2% at the end of 2018 from 9.7% at the end of 2017, meaning overall stressed advances including NPLs in Bangladesh amounted to 20.5% at the end of 2018 compared with 19% at the end of 2017, according to rating agency Standard & Poor’s.

Defaults on loans 

About 675 large borrowers identified as defaulters by the Credit Information Bureau (CIB) – a part of Bangladesh Bank that monitors the credit profile of corporations and individuals – have obtained a stay order from the High Court. This means their defaulted loans no longer appear in the CIB database and banks can report them as non-classified. These loans amounted to Tk792.4bn ($9.35bn) as of January 10, 2019, according to the central bank. At the end of June 2019, the banking sector’s total defaulted loans stood at about the equivalent of $13.2bn but, after taking into account rescheduled and restructured loans, it rises to $28.3bn, according to central bank data.

“Sadly, the NPL trend has been worsening,” says Syed Rahman, chairman of the Association of Bankers Bangladesh and chief executive officer at Dhaka Bank – a small commercial bank with 400,000 clients and $2.5bn in assets. “In my view, this is a cultural issue. The problem started a long time ago when some companies borrowed money from state-owned banks but did not pay it back. However, the banks continued to issue loans to these companies. This set an example for companies in the country more generally. The phenomenon spread to the other banks.

“The main problem is one of governance at the state-owned banks. There is also an issue related to the capacity of the judicial system. It can take up to eight years to foreclose on a defaulted loan. I think there must be exemplary punishment of some defaulters if we want to change the corporate culture. In this way, the others will learn,” he adds.

Bank credit to the private sector remains at about 40% of gross domestic product (GDP), estimated at $315bn, while total stressed advances amount to almost 9% of GDP, according to the IMF. 

Capital shortfalls 

The shortfall in state-owned banks’ required capital stands at about 1% of GDP, based on the authorities’ estimates. The shortfall in NPL provisions has been growing fast and reached almost 12% of required provisions at the end of 2018, from close to zero during 2013 to 2014, according to the IMF. 

Bangladeshi banks have to maintain a minimum capital adequacy ratio of 12% in line with Basel III requirements. Six state-run banks, three private commercial banks, and one foreign bank had a combined capital shortfall of Tk266bn in December 2018, according to the central bank. Bangladesh Krishi Bank had the biggest shortfall at Tk84bn, followed by Janata Bank at Tk585bn and Sonali Bank at Tk532bn. 

Mr Rahman thinks the NPL crisis is likely to worsen before the level of bad loans plateaus. However, he believes the risk of a run on the banks or a systemic banking crisis is low, as the Bangladeshi authorities would step in. “Some banks are certainly vulnerable,” he adds. “With so many banks in the system, competition is unhealthy. It means that small borrowers have access to a lot of money. ”

Missing repayments

In its financial sector stability review of Bangladesh in September 2019, the IMF concluded that certain well-connected and rich Bangladeshi businessmen understand clearly that “there is no [appetite] to enforce repayment of their loans”. 

“There seems to be a deep-seated pattern of non-payment of loans by certain segments of the population,” the report says. “The IMF mission understood that important and connected borrowers default because they can.” Those borrowers entertain expectations – based on experience – that being late in meeting their commitments will put pressure on lenders and allow them to renegotiate their obligations downwards.

The SOCBs are regularly re-capitalised by the government, enabling them to continue functioning. During the current financial year, it plans to inject Tk15bn to help them meet their capital shortfall. During the past 17 years, the government has injected a total Tk206bn of taxpayers’ money into the state-run banks, according to figures from the Ministry of Finance.

“The Bangladeshi banking sector is sailing through rough weather,” says Ali Reza Iftekhar, managing director and chief executive officer at Eastern Bank. “Global credit ratings giant Moody's has put the banking system on ‘negative watch’ despite the country's robust economic growth. The reason for the negative outlook is the worsening asset quality, and underlying weaknesses in corporate governance, especially at state-owned banks, has led to NPL ratios rising.”

Eastern Bank has the lowest NPL in Bangladesh, at only 2.35%. At the end of 2018, it had a return on assets (ROA) of 1.15% and a return on equity (ROE) of 13.83%. Its cost-to-income ratio is 45.63% and it has total assets of Tk199bn. In August 2019, it had 85 branches and 202 ATMs. 

Calls for reform 

The IMF is calling for the Bangladeshi authorities to adopt measures to enhance banking regulation and supervision; reform SCOBs; tighten the criteria for loan rescheduling and restructuring; strengthen banks’ corporate governance; and enhance legal systems to accelerate loan recovery. 

“The banking system is overall high risk by global standards, bifurcated by strong and very weak banks,” says Michael Puli, associate director at financial institutions ratings at S&P Global Ratings. “There remain many issues that undermine system stability, although delays to address these fundamental issues – in other words, regulatory forbearance – offer short-term respite. Furthermore, the underdeveloped nature of the capital markets and low exposure to international for-profit investors offers some protection from capital flight that would otherwise undermine some banking operations.

“System stability would be enhanced by ‘qualitative’ reforms, given the problem is not necessarily with rules and regulations on paper, but with the enforcement of those rules and regulations. Enforcement is hampered in a number of ways but ultimately derives from a lack of strong, independent and well-resourced institutions.”

Bangladesh's banking authorities emphasise that high NPL ratios are concentrated in only a few banks, particularly SOCBs, and that NPLs in the rest of the industry are relatively moderate. They stress that in some cases an adverse shock outside the borrowers’ control led to the NPL in the first place. In these circumstances – to mitigate the impact on economic growth and jobs – they believe a loan rescheduling is preferable. The authorities say the limit of a maximum of three loan reschedulings is now strictly enforced and that all rescheduled loans must be adequately provisioned.

Promoting consolidation

Experts say that Bangladesh's banking authorities are now working on a legal definition of ‘wilful defaulters’ that would allow them to take more effective steps against them. They are also discussing a bank merger policy to promote consolidation of the banking sector, and setting up an asset management company that would take over NPLs from banks.

The authorities told the IMF that the central bank does not allow any regulatory forbearance, but at the same time it takes into account potential economic costs when deciding whether to provide relief to borrowers.

However, Transparency International Bangladesh (TIB) says it is concerned by Bangladesh Bank’s recent decision to allow another round of rescheduling by several leading repeat loan defaulters. “An unholy alliance has acted to protect the interest of the habitual defaulters in the banking sector,” says Dr Iftekhar Zaman, executive director at TIB. “We call upon the government to acknowledge the deep crisis in the banking sector and, by shunning the denial syndrome, form an independent banking sector reform commission so as to develop a national strategy to address the deepening crisis.

“Loan defaulters – irrespective of identity or status – cannot be allowed to dictate terms to Bangladesh Bank and cause non-compliance of its own policy decision to get illegitimate extension of endless privileges of rescheduling, nor can Bangladesh Bank allow itself to be held hostage and continue to accumulate ever-greater risks to the sector.”

Jump in deposits 

There has been a sizeable increase in deposits in Bangladesh over the past decade. Total bank deposits stood at Tk10,880bn in March, up from Tk2320bn in June 2008, according to Bangladesh Bank. Total bank credit jumped to Tk9240bn in March from Tk1820bn in June 2008.

A total 3228 branches of both privately owned and state-owned banks were established in Bangladesh during the past decade, taking the total number of bank branches in the country to 10,114 in June 2018.  

The industry as a whole had an ROA of 0.4% in 2018 and an ROE of 5.3%, according to the central bank. SOCBs had an average ROA of -1.3% in 2018 while the ROA at specialised banks was -2.8%, at private commercial banks 0.8%, and at foreign commercial banks 2.2%. In 2018 the ROE at SOCBs was -29.6%, at specialised banks -13.5%, at private commercial banks 11%, and at foreign commercial banks 12.4%. 

“The economic growth during the past 12 years has been phenomenal,” says Rahel Ahmed, managing director and chief executive officer at Prime Bank. “Some people describe it as a miracle. The country has had a great deal of political stability with the same prime minister, Sheikh Hasina, since 2009. Our bank has been particularly strong in corporate banking and has served all the corporate needs of big companies, especially in the ready-made garment sector, which is very big in Bangladesh.

“Since 2015, we have introduced a more centralised model. Previously, loans had been booked through the branches but we realised that branch managers suffered from a lack of process and were not sufficiently monitoring the loans granted. The branches now focus on transactional banking and product and sales support,” says Mr Ahmed. Prime Bank’s NPL ratio stood at 6.45% at the end of December 2018, its total deposits amounted to Tk198bn during 2018 and it has 146 branches throughout Bangladesh. The bank declared a 12.5% cash dividend for 2018.  

Naser Ezaz Bijoy, chief executive officer at Standard Chartered in Bangladesh, says: “We have managed to keep our NPLs down to low levels. We apply stringent, international standards in terms of provisioning, in addition to complying with local regulations.” The bank has 24 branches in the country and had total deposits of Tk290.7bn at the end of 2018.

“The Bangladeshi economy has been performing very well and that has benefited our bank. Standard Chartered has a presence in about 60 countries, but in terms of profitability, Bangladesh is among the leading countries in which the bank operates. We have been a pioneer in a number of banking products in the market, throughout our bank’s 114 years of uninterrupted journey in Bangladesh,” adds Mr Ezaz Bijoy. “Our strategy is to remain the only universal bank in the country – offering everything from retail current accounts to merger and acquisition advisory and investment banking. We remain a key partner in progress for the country – supporting 25% of US dollar clearing and 8% of country trade.”

Islamic banking hopes

Islamic banking is growing fast in Bangladesh and the country had eight fully fledged Islamic banks with more than 1000 branches in May 2019. The ROA of the Islamic banks fell to 0.56% in 2018 from 0.7% during 2017, while ROE fell to 10.7% from 13.1%, according to Bangladesh Institute of Bank Management. 

“A number of fully fledged Islamic Banks has been established, while a good number of conventional banks have come forward to offer services compliant with Islamic sharia through the opening of Islamic branches along with conventional ones,” says Mr Iftekhar at Eastern Bank. “There is also a trend of converting conventional banks into Islamic banks.”

Many believe that Bangladesh’s banks will increase in importance as the country becomes wealthier and the population develops, including in financial literacy. “This is a double-edged sword,” says Mr Puli at S&P. “As banks increase penetration, they may need to access additional funding through capital markets. With the domestic capital market remaining very narrow and competition from national savings certificates high, banks may need to tap international capital markets.

“However, if fundamental system-wide issues have not been addressed, international investor appetite may be low and constrain future growth. Even if banks were able to source a material part of their funding from international investors, these funds would face the scrutiny and potential volatility associated with investor sentiment.”

Some of Bangladesh’s state-owned banks are being cushioned for now by the country’s phenomenal economic growth, but in the case of a serious economic downturn, they would be highly exposed. 


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