The International Monetary Fund has identified the problems in the banking system, including the high volume of defaulted loans, as one of the three domestic risks that derail the economy in the short- to medium-term.

The likelihood of the problems in the banking system spilling over into the wider economy range from medium (10 to 30 percent chance) to high (30 percent or more), said the IMF staff report.

The other domestic risks stem from the slow progress in resolving the Rohingya crisis and weakened donor support and the higher frequency and severity of natural disasters related to climate change.

Subsequently, the 42-month programme has focused mostly on fixing the banking system, stipulating as many as 11 reform actions in this area.

As part of the oversight mechanism, the Washington-based multilateral lender has stipulated that the Bangladesh Bank sends monthly to quarterly data on the health of the banking system. This would inform whether the reform measures are having their desired impact.

Chief among the reform agenda are classifying defaulted loans in line with international best practices and formulating a resolution strategy for the soured loans.

By June, BB will restart reporting banks' rescheduled loans alongside the non-performing loans (NPLs) in the annual financial stability report to better reflect the true state of distressed assets, said BB Governor Abdur Rouf Talukder and Finance Minister AHM Mustafa Kamal in their letter of intent to the IMF.

"We plan to reduce the time needed before a bank could write off bad loans," they said.

Fully adopting the Basel III standards for the measurement of banks' financial statements and provision framework and the adoption of the International Financial Reporting Standard 9 (IFRS 9) was another reform action demanded by the IMF.

The government is committed to developing a plan for this by 2023 and fully adopting the IFRS9 by 2027 and will seek IMF technical assistance for implementing the expected credit loss-based provisioning.

"We are committed to adopt a holistic and time-bound NPL resolution strategy."

To reduce bank balance sheet weaknesses, particularly of the state-owned commercial banks (SoCBs), the government will pursue bank-specific resolutions.

BB is developing an enforceable Memorandum of Understanding (MoU) to reduce the average NPL ratio to below 10 percent for SoCBs and below 5 percent for private commercial banks (PCBs) by 2026.

These MoUs will also aim to increase capital adequacy ratios and provisioning coverages of SoCBs to 10 percent and 100 percent and of PCBs to 10 percent and 100 percent by 2026.

To strengthen the corporate governance of SoCBs, a committee is examining the existing policy for nomination and appointment of directors of SoCBs to suggest policy recommendations.

Further strengthening monitoring and supervision of the banking sector is needed to enhance financial sector resilience, the IMF staff report said.

"Structural weaknesses in supervision, regulation and governance, coupled with high NPLs and low capital in SoCBs, could be a drag on medium-term growth prospects," it said.

Steps will be taken to improve the stability, soundness and reach of the financial system, anchored by clear oversight responsibilities, strong risk-based supervision (RBS), and proper managerial and operational controls.

RBS will be adopted by 2025, while BB will complete the pilot RBS action plan by finalising the assessment of the three pilot banks, including one Islamic bank, by June.

Developing a macroprudential strategy and conducting scenario-based macroprudential stress tests would help manage systemic risk, the IMF staff report said.

The government will also strengthen credit infrastructure and collateral valuation framework.

Furthermore, the government plans to expand the mandate of the credit information bureau (CIB), allowing it to share data with private borrowers.

The government plans to submit to the parliament the Bank Companies (Amendment) Act 2020 and the Finance Companies Act 2020, drafted in line with best practices by the end of September and the Bankruptcy (Amendment) Act 2020 and the Money Loan Court (Amendment) Act 2003 by June 2024, and the Negotiable Instrument (Amendment) Act 2020 by June 2025.

These reforms will help modernise the financial sector, improve the legal environment of credit and business activities, enhance the insolvency regime and facilitate recovery of loans, the IMF staff report said.

The government also committed to strengthening governance and combating corruption as part of the $4.7 billion loan programme.

Moving toward international best practices for risk-based supervision would help further strengthen the AML/CFT framework and mitigate substantial money laundering (ML) risks, including from cross-border activity and trade-based ML.

The Companies Act will be amended to facilitate the information collection for fully identifying the ultimate beneficial ownership in the financial sector.

"We remain committed to combat corruption by safeguarding the independence of the Anti-Corruption Commission," said Kamal and Talukder.