A strong banking system makes a strong economy

For the last several years, the banking sector in Bangladesh has been playing an important role in our USD 300-plus billion economy where banks comprise more than 80 percent of all financing activity. Besides providing investible funds to both the public and the private sector, they are also facilitating international trade and service payments, generating employment, earning foreign remittance, strengthening rural economy, developing the housing sector, etc. But in recent years, this crucial sector has been facing many challenges, which include among others, a big volume of non-performing loans (NPLs), lack of corporate governance, increasing capital shortfall and slow loan recovery that have raised serious concerns about the efficiency and soundness of this sector. 

According to the "Global Competitiveness Report 2019" of World Economic Forum, Bangladesh scored 38.3 out of 100 and ranked 130th out of 141 countries in soundness of banks. This ranking is the lowest among South Asian countries (India scored 60.4 and ranked 89th, Pakistan ranking 93rd, Sri Lanka 94th and Nepal 106th). In defining banks' soundness, weak monitoring, growing default loans, lack of good governance, balance sheets and availability of funds, and capacity to repay were taken into consideration. Another report (Financial Stability Report, 2019) unveiled by the Bangladesh Bank (BB) shows that the country's banking sector maintained the lowest capital adequacy ratio (CAR) in 2019 compared with neighbouring countries (India, Pakistan and Sri Lanka). Bangladesh maintained the CAR at 11.60 percent, way less than 17 percent in Pakistan, 16.5 percent in Sri Lanka and 15.1 percent in India. Capital adequacy ratio (CAR) is the reflection of all financial indicators of banks, including the ratio of defaulted loans, the capability of keeping provisioning against regular and classified loans and the actual situation of corporate governance.

It is an open secret now that the country's banking sector has been mired in a series of scams and irregularities, such as the funnelling of loans worth billions of taka by violating banking rules and procedures to influential people, who have been known to be lax with repayments. As a result, as of September 2019, defaulted loans in the banking sector stood at a record Tk 116,288 crore. Disappointingly, instead of taking any strict action against loan defaulters, Bangladesh Bank (BB) opted for a relaxation of various rules. Under the relaxed policy offered in 2019, the central bank has given special loan rescheduling facility to loan defaulters, allowing defaulters to regularise their loans for 10 years by paying just two percent of their loans as down-payment. As a result of the central bank's decision, last year, a record Tk 52,770 crore was rescheduled, but of them, Tk 13,284 crore have turned sour again, according to BB data. BB data also showed more than 50 percent of the defaulted loans amounting to Tk 48,057 crore were with the eight state-run banks and 41 private banks together had defaulted loans amounting to Tk 44,174 crore, as of December 2019.

Industry experts, however, have strongly criticised the policy. Khondkar Ibrahim Khaled, former deputy governor of Bangladesh Bank, said, "The policy will destroy the banks." The policy will have serious "side effects" on the money market. When loans are not recovered for a long time, lending rates go up and hurt businesses, he added. In a similar vein, Ahsan H Mansur, executive director of the Policy Research Institute said, "Actually, this is just an eyewash to camouflage the actual situation of defaulted loans." Wholesale rescheduling indicates that banks are trying to clean up their financial balance sheets artificially in a bid to show profits. The volume of non-performing loans (NPLs) would have increased significantly if banks had not regularised the defaulted loans in a relaxed manner, he pointed out. These numbers (reduce defaulted loans) may look good on paper but in the long run the policy would deteriorate the banking sector's financial health because long-term loan rescheduling would hurt and squeeze the banks' capacity to give fresh loans to productive sectors which in turn could bring disaster to the economy.

Amid such a situation, the coronavirus outbreak in March added salt to the wound for the banking sector. Due to the ongoing economic fallout of the coronavirus pandemic, most of the business houses have been forced to take out a large amount of money to pay wages and salaries to employees and for other operational expenditures. Individuals too are withdrawing deposits from their savings account, cashing out fixed and deposit pension schemes prematurely to support their family expenses. According to Bangladesh Bank, bank deposits decreased to Tk 12,28,000 crore at the end of this April from Tk 12,53,600 crore in January 2020. Moreover, the governments' recent move to cap bank interest rates within 9 percent against loans and 6 percent for deposits will surely encourage borrowing but banks will face hurdles in attracting depositors. Furthermore, the government decision to raise excise duty by 20 to 25 percent in various slabs on deposits above Tk 10 lakh in the current budget for 2020-21 is expected to further discourage depositors to park their money in the banking system.

Unfortunately, while the banking sector is passing through such a financially difficult period, government's borrowing from the banking system continues to rise. Data shows in the just concluded fiscal year the government's net borrowing from the banking sector stood at Tk 85,000 crores, up by Tk 37,633 crores from the original estimate due to a dismal revenue collection amid the global coronavirus outbreak. For this fiscal year (2020-2021), the government has set its bank borrowing target at Tk 84,983 crore to meet part of its Tk 1.9 lakh crore budget deficit. It seems the current trend of high government borrowing would increase further in the coming months due to a dismal revenue collection amid the global coronavirus outbreak. Economists and bankers anticipate all this to definitely put further  pressure on bank deposits in the coming days, which will ultimately increase the risk of crowding out the private sector with adverse effects on private investments.

Once the outbreak is contained and the economy resumes its normal activity there will be more demand for money, both from the private and public sector. Private sector will be needing money for business structuring and the government will need to spend a substantial amount of money on development projects to boost up economic activities and to create aggregate demand, but the question remains, how can banks lend smoothly if they do not have adequate funds. To answer the question, economics 101 tells us that when the economy starts growing, the country needs more sources of finance and more sources of credit. Today, there is a strong need for other types of institutions like venture capital, private debt equities, strong bond and capital market, etc., so that businesses can raise longer-term finance through these institutions and reduce their reliance on short-term bank finance. Similarly, the government should also focus on availing foreign grants as well as low-cost funds from external sources and should take initiatives to strengthen the bond market as the country needs long-term investment to achieve its development goals and thus reduce dependency on bank borrowing.

Therefore, it is high time for our policymakers to understand that a healthy, strong and efficient financial sector is a vital component of economic growth. Anne-Marie Gulde-Wolf, the International Monetary Funds (IMF's) Asia-Pacific Deputy Director said: "Reforming the banking sector is one of the top priorities for the government to enhance the resilience of the economy...Comprehensive reform is required to address banking sector weaknesses. Measures should include enhanced banking regulation and supervision, state-owned commercial banks reforms, tighter criteria for loan rescheduling/restructuring, stronger corporate governance in the banking sector, and enhanced legal systems to accelerate loan recovery." Therefore, the sooner the government starts to implement the above recommendations, the faster Bangladesh will embark on a path that would create a stronger economy.

Abu Afsarul Haider is an entrepreneur. He studied economics and business administration at the Illinois State University, USA. Email: afsarulhaider@gmail.com