Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
Asia-PacificApril 3 2018

Will Bangladesh realise its potential?

Bangladesh’s banking sector has yet to resolve problems relating to non-performing loans, governance and the soundness of its supervision. But a large population that is still predominantly financially excluded offers local banks enormous potential, as Stefania Palma reports.
Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
Dhaka

Bangladesh’s banking sector is facing some fundamental challenges. Non-performing loans (NPLs) now account for 10.5% of the sector’s total loan book, the country has a history of banking fraud, and governance in the sector has plenty of room for improvement.

Market participants point to overbanking, supervisory flaws and an ineffective legal system to explain the current state of Bangladesh's banking sector, where public sector banks tend to struggle the most.

But Bangladeshi lenders also have reasons to be excited. Bangladesh is home to 160 million people but only about 30% of the population has a bank account. The potential for retail banking is enormous, and efforts by Bangladesh Bank, the country's central bank, to increase financial inclusion through digital payments are including more people in the formal sector. The country's economy also remains one of the fastest growing in the world, with the Asian Development Bank estimating 7.2% gross domestic product growth for 2017.

Bad loans

When asked to pinpoint the biggest problem in the domestic banking sector, market participants are quick to say NPLs. The sector’s gross NPL ratio stood at 10.5% in March 2017, up by 1.3 percentage points from December 2016, with public sector banks often being the biggest offenders.

Rising NPLs are in turn hitting Bangladeshi banks’ profitability. In March 2017, the sector’s return on assets and return on equity dropped quarter on quarter from 0.8% and 5.4% to 0.6% and 4.2%, respectively, according to Bangladesh Bank.

Poor risk management and governance in the banking sector have contributed to the accumulation of bad debt in Bangladesh. But now that banks are trying to resolve the issue, snail-paced and dysfunctional legal processes are throwing obstacles in their way.

Legal roadblocks

“Our legal system needs some change to meet the need of time. We still follow English laws, for that matter. India has improved on that but we have not had a significant leap from there,” says Syed Mahbubur Rahman, managing director and CEO at Dhaka Bank.

The country's High Court does not have dedicated benches (or sub-courts) for banking issues, meaning default cases may get mixed in with murder cases and the like. What is more, once a verdict is finalised, the case moves from the lower to the higher court and the execution of the verdict is an additional process. In the most extreme default case, it took Dutch-Bangla Bank (DBBL) about 15 years to sell a defaulted clients’ mortgage securities to recover the bad loan.

Because of the dysfunctional legal system, Bangladeshi banks are forced to resolve NPL issues without going to court – at a cost. “We try to get as much as possible without going through the legal system, which means we have to give more concessions than otherwise required,” says Abul Kashem Shirin, managing director and CEO at DBBL.

Worse still, defaulting borrowers often take advantage of this flawed system. “Defaulters try to buy time as much as possible. You cannot bring them to the discussion table for negotiations. That is one of the bottlenecks in terms of improving the recovery. If you could immediately bring them to the discussion table, then definitely it would create some level of fear in them,” says Mr Rahman.

Indeed, Bangladesh lacks an official arbitration system for loan recovery, meaning there is no formal procedure to discuss a client’s case before taking it to court. “Whatever happens, it happens post filing a case. But that doesn't help [because] by that time things [with the client] get very bitter and [the] relationship gets sour,” adds Mr Rahman.

A crowded market

The high number of banks in Bangladesh – 57 in total – also explains the NPL problem. A crowded market means fierce competition, which pressures banks to boost lending to meet targets. “There aren’t too many good customers across the board. A customer that needs $100m but receives $500m from banks might be tempted to use those funds to buy fixed assets, for which you might not get return overnight and you might default on your debts. Everyone has targets. And since you want to grow your book faster, you go to the corporates,” says Mr Rahman.

Sound supervision is deemed essential to counter the NPL problem, especially in a crowded market. “People have to play their respective roles. We need not encroach on somebody else’s role, starting from regulatory bodies down to the employees,” says Mr Rahman.

However, market participants argue this has not always been the case in Bangladesh. For instance, the number of banks could jump to 60 by the end of 2018 as finance minister Abul Maal Abdul Muhith is set to order the issuance of three new banking licences. Although Bangladesh Bank is the banking supervisory body, this is not the first time Mr Muhith has directed the central bank to issue licences, raising questions on the independence of the central bank and its ability to properly regulate the banking sector.

Liquidity squeeze

In such a crowded sector, where lenders are tempted to overlend to keep growing their business, Bangladeshi banks’ credit growth exceeded the central bank’s expectations by 4 percentage points in the six months to December 2017, reaching year-on-year growth of 20%.

In response, in January 2018 Bangladesh Bank announced it would slash the advances to deposit ratio (ADR) ceiling from 85% to 83.5% and that lenders needed to comply by June. “There was a sort of artificial panic in the industry. Some banks [had gone] up to 91%. A 5% to 6% drop [in the ADR] is a lot of money,” says Ali Reza Iftekhar, managing director and CEO at Eastern Bank, whose ADR stands at 82.5%. “[Banks thought] ‘I cannot call off loans, so I have to bring in deposits’. That created an artificial crisis in deposits. Liquidity was a bit stressed and it still is.”

We see [the industrial sector] as an opportunity for our bank. Financing may be topped up by the borrowing of funds through [our] offshore banking units

Mahbub ul Alam

In the end, banks successfully lobbied the central bank to extend the deadline from June to December 2018. “That will ease up pressure on liquidity a little bit,” says Mr Iftekhar.

Foreign bank Standard Chartered Bank Bangladesh, with an ADR below 74%, was not directly affected by the central bank’s policy move but it remains prudent. CEO Naser Ezaz Bijoy says: “We have been cautious on where to expand on the credit side... and we have increased our efforts to mobilise deposits to maintain [an] additional liquidity buffer.” 

According to former central bank governor Atiur Rahman, having direct conversations with banks in breach of ADR limits – rather than issuing a policy change affecting the entire sector – could have avoided panic across the industry. What is more, with banks now chasing deposits to meet the new 83.5% ADR, deposit rates have almost doubled to 9% to 10%. That means loan rates will grow to at least 12%, says Mr Rahman. “[All the] efforts made over the past decade to bring down interest rates to single digit for the [benefit] of investors have been defeated because of one push by the central bank,” he adds.

The ADR move alone did not trigger the liquidity crunch, however. The recent rise in commodity prices means the trade deficit for oil-importing Bangladesh has deteriorated. Harsh flooding in 2017 also pushed Bangladesh to import food grains after years of self-sufficiency, while remittance volumes have softened in the past two years. These trends have all contributed to volatility in the Bangladeshi taka, pushing borrowers who do not have a natural US dollar hedge to take out taka loans, adding further pressure to liquidity in the banking sector.

Market participants believe that having a deeper domestic bond market would offer banks an additional source of liquidity, reducing volatility. Today, lenders rely solely on deposits for liquidity, meaning there is a maturity mismatch in their balance sheet. Deposits tend to have three to six-month tenors, while banks are lending at five to seven-year maturities.

Banking commission talk

In light of Bangladesh’s NPLs, governance and overbanking issues, a group of market participants has suggested setting up a banking enquiry commission to help supervise the industry and enforce mergers and acquisitions among weaker banks.

Bankers’ thoughts on this are mixed. Eastern Bank’s Mr Iftekhar believes this commission is not necessary, since the central bank has sufficient power to regulate the banks. “It is whether you are going to implement and execute the power. Introducing another commission will actually create more problems in the industry. You are bringing in good efforts without having any knowledge of the banking sector. That would be a disaster for the industry,” he says.

Members of this hypothetical commission would most likely be appointed by the government – in which case, the question of supervising the banking sector independently might not be resolved.

But according to DBBL’s Mr Shirin, the commission could be a first step in the right direction. “It is not clear how the banking commission [would] work, but it is better to have a high-level, powerful, independent and competent commission,” he says. 

Some market participants, however, argue that the key is changing the sector’s culture. It is crucial, for instance, to ensure that banks' boards of directors do not approve loans without the independent input of credit officers. Standard Chartered’s Mr Bijoy says: “Relationship managers and the executive management team are expected to know the clients and their financial health intimately. Delegation for approval authority is best to be vested on the executive committee with full accountability of the executives and strong oversight [from the] board. Only the large loans are expected to require board approval.”

Bank capitalisation is another hot topic in Bangladesh as lenders are gearing up to meet Basel III guidelines by 2019. A number of private sector banks are already Basel III-compliant, while public sector banks tend to fall short of these requirements.

In February, finance minister Mr Muhith said that four state-owned and three private banks require capital replenishment of about Tk100bn. The government is also stepping in to support Farmers Bank – a private sector bank set up in 2013 that was on the brink of bankruptcy at the end of 2017 after a run on deposits and alleged fraud. Mr Muhith announced the state will step in to save the lender by buying a 60% stake in Farmers Bank.

Chasing retail

While governance issues in Bangladesh’s banking sector remain significant, lenders still enjoy a market with strong potential. The retail segment is particularly exciting considering the vast number of unbanked people within the country's population.

DBBL has one of the largest retail deposit bases in Bangladesh and about 5000 ATMs across the country. But retail still only accounts for less than 5% of the bank’s lending portfolio. “From 2017, we have changed our lending strategy to focus more on small and medium-sized enterprises and retail. On the liability side, no other bank in Bangladesh has our kind of retail depositor customer base. If we can pick up even just 5% to 10% of our retail depositors for our lending business, that will go a huge way to growing our retail portfolio,” says Mr Shirin. Retail could account for 50% of DBBL’s portfolio in the next five to 10 years.

Defaulters try to buy time. You cannot bring them to the discussion table for negotiations. That is one of the bottlenecks in terms of improving [NPL] recovery

Syed Mahbubur Rahman

Dhaka Bank is also chasing retail, diversifying its lending and deposit portfolio away from corporate clients, which tend to move easily to capture the best rates available. Retail deposits are less expensive and are stickier – meaning they are less sensitive to rate moves. As of now, retail does not even account for 2% of Dhaka Bank’s lending portfolio but that could reach 5% in the next two years.

Eastern Bank is also keen to boost its retail lending, which now accounts for 30% of total loans, especially as Bangladeshis’ disposable income is rising. Consulting firm Boston Consulting Group projected in 2015 that the annual income of about two million Bangladeshis will reach at least $5000 every year until 2025.

Eastern Bank’s approach to boosting its retail business will be digital, says Mr Iftekhar. The bank has already launched an e-commerce platform hosting more than 100 retailers.

Other priorities

But not all banks are prioritising retail. Islami Bank Bangladesh (IBBL) is keen to continue servicing the industrial sector. IBBL managing director and CEO Mahbub ul Alam says the bank will continue to support the government and the private sector in their aim to “implement high-end industrial investment in transformational infrastructure projects”. He adds: “We see this as an opportunity for our bank. Financing may be topped up by the borrowing of funds through [our] offshore banking units.”

IBBL also focuses on managing the country’s import and export flows, taking up 9.2% and 9.3% market share, respectively. Remittances is a further key business for the lender, which accounts for 22% of market share. To continue growing in this field, the bank plans to open branches in Jeddah and Riyadh in Saudi Arabia – two key sources of remittance flows for Bangladesh – in 2018. “We are also trying to open more branches in Djibouti and Sudan, to support trade business,” says Mr Alam. IBBL is one of the few domestic banks in Bangladesh to have international units.

Bangladesh is faced with a number of shortcomings in its banking sector, including high NPLs, poor governance and ineffective supervision. But the country is also one of the most exciting growth stories in the region, offering immense potential to its lenders.

Was this article helpful?

Thank you for your feedback!