How to choose a good bank
Depositors looking to put money in banks often face the risk of selecting a bad bank. This is because often they don't have complete information about the financial and other conditions of the banks. For a safe and good banking experience, it is essential to recognise strong banks, which can be done in the following ways.
A good bank ensures quality of loans (assets) by selecting the right borrowers, sanctioning loans to various sectors in different sizes, and keeping collateral. It avoids credit concentration and aggressive lending to high-risk borrowers, and grants loans to those who have credit discipline. It is motivated by value-driven strategies rather than immediate performance-driven ones. A bank's performance can be measured by its loan quality: if it has a small amount of distressed assets, its quality is good, but a bank with huge distressed assets—which include non-performing, rescheduled, restructured and other loans stuck in money loan courts—is surely a bad one. Such a bank fails to be profitable because it has to maintain a provision against non-performing assets from its profits. A bank that has a non-performing loan (NPL) rate of less than five percent is a good bank in Bangladesh's context. Depositors should look at this rate.
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There is a single-borrower exposure limit, indicating the maximum amount of loan that banks can grant to one borrower. A bank can sanction 25 percent of its capital at most to a single borrower. It can also make a large loan that's at least 10 percent of its capital. It should not extend such loans frequently because doing so creates a concentration risk. It also fails to construct a diversified portfolio with many large loans. In contrast, when a bank extends many small and medium loans, its portfolio is diversified, making a trade-off between risks and returns. Depositors should avoid banks that have high proportions of large loans.
Capital is a parameter that's used to understand banks' loss absorption capacity. A bank must have sufficient capital for solvency purposes. When the capital is adequate, it can absorb significant unforeseen losses. Any loss that arises mainly from credit, interest rate, liquidity, foreign exchange and/or price risks is adjusted against the capital. Hence, a bank must keep a minimum amount of capital against its risk-weighted assets. If it possesses more risky assets, its capital requirement is high. A sound bank also maintains additional capital rather than the minimum. It keeps some capital buffer to face the loss emerging from unfavourable economic conditions and adverse business cycle. Depositors must also look at the overall capital position of a bank.
Liquidity is the ease with which an asset can be converted into cash without affecting its market price. Liquidity risk is a sudden surge in liability withdrawals that may leave banks in a position of having to liquidate assets at a very short notice and low prices. It is one of the most significant risks that banks need to manage to keep the trust of their depositors. When a bank faces a liquidity problem, it generally borrows from the money market. But when it tends to borrow at high interest rates, that signals that the bank is at a serious liquidity risk. It may also tend to collect deposits at abnormally high interest rates. As a last resort, it may borrow from Bangladesh Bank (BB). Sometimes, it may even need special liquidity support from BB to continue its operations.
Depositors should also know whether a bank can maintain regulatory reserves required by the central bank. Every bank has to maintain certain statutory reserves in cash and other assets. Failure to maintain the reserves leads to punitive action. Recently, several banks have failed to maintain these reserves, for which they were fined.
In a good bank, there are checks and balances between the board of directors and the top management where the former ensures that the bank's affairs are carried out competently, ethically, and in accordance with the law and policies; it also ensures that quality services are provided. The latter have to supervise all operations of a bank. There must be a fair participation of all directors in policymaking. The management must have freedom in its operations and the right to say "no" to the board of directors.
However, sometimes a bank is dominated by the chairpersons or directors from the same family. The chairperson makes major decisions on issues such as lending, recruitment, and large purchase. This type of governance puts the bank at a high risk. The banks that are currently facing problems with liquidity, NPLs, capital and provision were largely dominated by their respective chairpersons or a few influential directors. We have seen reports in the media about some banks afflicted with this problem. Depositors must be careful about putting their money in these banks.
The BB discloses information indicating the quality of banks. Recently, it categorised banks in red, yellow and green zones based on their performances. Banks in the green zone are safe, while those in the red zone are risky. The central bank also runs stress testing on banks to better understand their financial position and risks. The test shows the shock absorption capacity of banks under different adverse conditions. A good bank is highly shock-absorbent.
The BB analyses a bank's conditions by the CAMELS (capital adequacy, assets, management capability, earnings, liquidity and sensitivity) rating. Although this rating is not made public, every bank knows its own rating. In addition, banks are also rated by external credit assessment institutions every year. When a bank attains a good rating, it is advertised in newspapers. This rating is an important indicator of performance.
A good bank is also consistent in making profit; it declares a certain percentage of dividends every year for its shareholders and retains a portion of its profit to increase capital base and expand business. Its share price does not change abruptly. A good bank earns a decent return on assets and equity. It has respectable earnings per share, and so is its net asset value. The financial statements of banks contain these sets of information which depositors can look through.
Depositors should not necessarily make all these analyses by themselves. Most analyses are readily available in annual reports. They can depend on media reports too. If they are confused while selecting a bank, they can simply talk to bankers and experts. What's most important is that they need to be conscious about choosing a good bank. Doing so can reduce the risk of losing money.
Dr Md Main Uddin is professor and former chairman of the Department of Banking and Insurance at the University of Dhaka. He can be reached at mainuddin@du.ac.bd.
Views expressed in this article are the author's own.
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