Banking sector in search of respite

Banking sector is an important component of the financial system that mobilises resources for productive investments in a country which in turn contributes to economic development. Over the years the banking sector in Bangladesh has flourished in terms of the number of banks and their branches, amount of asset and contribution to the economy. The sector has also undergone several reforms and fallen under the jurisdiction of a number of acts for improving its efficiency. Nevertheless, the sector in recent times has been plagued by various problems including inefficiencies, malpractice and scams. This has impacted the soundness of the banking system in the country and resulted in huge losses in the sector. While the sector is yet to recover from these shocks, new challenges continue to appear in different forms. 

MAJOR CHALLENGES
One of the problems that banks, particularly state-owned commercial banks face at present is that of dealing with the high volume of non-performing loan. Though Bangladesh Bank adopted a flexible loan-rescheduling policy in December 2013 in order to provide respite to borrowers in view of the political turmoil and reduce the burden of non-performing loan on banks, the policy did not lead to fruition. Rather, the amount of non-performing loan has increased partly due to the flexible loan scheduling policy itself. Lack of proper screening of loan proposals and due diligence, non-adherence to project selection criteria, consideration of non-economic factors in sanctioning loans and lack of monitoring during project implementation are the major reasons behind high non-performing loan in Bangladesh. 
The high volume of non-performing loan is taking a toll on capital adequacy and profitability of banks. Capital adequacy ratio, measured as capital to risk weighted assets, is below the international standard of maintaining a minimum capital adequacy ratio of 10 per cent in state-owned banks. Non-performing loan coupled with lower demand for loan has affected the profitability of most banks. Return on asset and return on equity have been negligible and even negative in state-owned banks. This not only reflects the quality of assets in the banking system, but also raises concerns about the sustainability of these banks. 
With generous support from the government, state-owned banks were able to adjust their accounts and make up for their losses created through various financial malpractices. In order to strengthen the banking sector, Tk 5,000 crore was earmarked in the national budget. While the government is injecting capital into these troubled banks in order to keep them afloat, allocation for other priority areas including social sectors remain less than adequate. On the other hand, though financial inclusion in terms of population per bank branch has improved over the years, a large number of people still remain outside the purview of banking services. Thus, recapitalisation of these banks raises questions as regards the prioritisation of the allocation of public resources, particularly when state owned banks continue to be fraught with governance challenges. The fact that such capital infusion has not seen any improvement in the receiving banks is rather frustrating.

REFORMS UNDERTAKEN
In a bid to improve the performance of the banking sector the government of Bangladesh embarked on a policy of liberalisation through denationalising the nationalised commercial banks in the 1980s. In view of the deteriorated performance and inefficient resource management the government decided to open up the banking sector and adopt a number of reforms for the sector. As part of the reform process two of the six nationalised commercial banks were denationalised and a few commercial banks were given license to operate in the private sector to create competition in the banking sector. The reform process accelerated towards the end of 1980s and the beginning of the 1990s under the directions of the World Bank and the International Monetary Fund. The National Commission on Money, Banking and Credit was constituted in 1986 to look into the problems of the banking sector and suggest ways to overcome those under the direction of the World Bank. The Commission pointed out, among others, problems relating to the supervisory task of Bangladesh Bank and overall structure of the banking sector, and pointed out that non-performing assets required improvement. The consequent Financial Sector Reform Programme and Financial Sector Adjustment Credit carried out in the 1990s were geared towards implementation of various reform measures in the financial sector. The objectives of these measures were to liberalise interest rate; enhance the capacity of loan classification and provisioning; capital restructuring and risk analysis; strengthening the central bank; and improving the legal system and framework for loan recovery. 
Following the phase out of the Financial Sector Reform Programme in 1996, subsequent governments continued to undertake reform measures in the financial sector. The Commission on Banking and the Banking Reform Committee were formed in 1998 and 2002 respectively to make recommendations for the improvement of the performance of banks. A bill was passed in the parliament in 2003 to bring more reforms in the banking sector. Most important of the relevant initiatives was the Bangladesh Bank Amendment Bill, 2003 through which Bangladesh Bank received the autonomy to operate on its own and to formulate the monetary policy. The World Bank and the government of Bangladesh undertook a reform initiative called the Central Bank Strengthening Project to put in place a strong and effective regulatory and supervisory system for the banking sector of the country. The focus of this project was on three broad areas, those of (i) strengthening the legal framework; (ii) reorganisation and modernisation of Bangladesh Bank, and (iii) capacity building of Bangladesh Bank. 
Another major reform attempt was the corporatisation of four state owned banks into limited companies and restructuring of three state-owned banks in 2007 to operate as more of a commercial entity. Supported by the World Bank and monitored by the Bangladesh Bank, the reform initiative included measures such as selection of the chief executive officer, deputy managing director and four general managers of the state-owned banks through a competitive process, and fixation of the compensation package that was commensurate with the private sector and in accordance with respective performance records. Monitorable goals were set for cash recovery of non-performing loan, limits on new non-performing loan, operations, computerisation, income and profitability, increased net worth and disclosure.  
However, the reform initiatives for the banking sector in Bangladesh have not been able to deliver the expected results. Achievements in terms of efficient resource allocation through disbursement of credit to productive sectors, prudent risk analysis, supervisory and management quality have not been encouraging in many banks even after so many reforms since independence. Moreover, lack of governance has featured prominently in the recent years in several banks including the state-owned banks. 
Following the unprecedented level of misappropriation by the Hallmark group in 2012 from a state owned bank, a number of incidences of malpractices have been unearthed in other banks. These incidences have exposed serious flaws in the governance of the sector, the associated corruption in the sector and negligence of the responsible people. Sadly, the sector has not been able to make any visible progress in terms of restoring governa    nce since the Hallmark incidence.
Ironically, in most cases, these incidences have occurred in collaboration with officials and directors of banks through various types of dubious practices such as by setting up fake companies, forging bank documents, documenting fake board meetings and influencing the monitoring officials. Private commercial banks are not unscathed either. Fraudulent activities, which owners and the management have been party to, are also observed in these banks. This has compelled the central bank to appoint observers in a few banks. 

ROAD AHEAD
After several reforms in the banking sector since the eighties, the banking sector had begun to exhibit some signs of improvement in a few areas. However, recent shocks have exposed the fragility of the sector and pointed out that reforms in the sector have been incomplete. 
If the banking sector has to contribute to the economic growth of the country through mobilising resources for investment in productive sectors, it needs a massive overhauling and clean up. The required measures can be categorised into three broad areas - (i) strengthening internal governance of banks; (ii) improving oversight function; (iii) removing political influence.
Most banks suffer from shortcomings such as poor selection of creditors and politically motivated lending, poor risk management, lack of due diligence, weak monitoring and misreporting. There is a lack of transparency and accountability in case of credit approval, administration, monitoring and recovery processes. Credit concentration is common in many banks. Concentration of outstanding loans in the hands of a few business groups indicates high level of risk and vulnerability in the sector. This has exposed banks to high default risks. Given that a significant proportion of this loan is non-performing loan as highlighted above, this raises serious doubts in regards to the quality of credit. 
In view of the recent shocks in the banking sector and emerging challenges, a commission for the financial sector should be formed which will scrutinise the overall performance of the sector, assess the need of customers and the economy, identify the current problems and emerging challenges, and suggest concrete recommendations for prudential banking to be implemented in the short to medium terms. Considering the emerging need and in order to build up more transparent and responsible banking sector, the commission can also include non-banking financial institutions such as insurance companies and the capital market under its jurisdiction as they are interconnected. The broad terms of reference of the Commission will be to critically assess the problems and weaknesses of the banking industry in order to find whether there is any disconnect between demands of the growing economy and the realities of a backdated financial system that is failing to meet the emerging need. On the basis of a comprehensive scrutiny the commission will prepare guidelines and make recommendations as regards automation, risk management, internal control and the role of various players in banks and other financial institutions. 
As the country desires to step into a higher growth momentum through exploring its potentials, the demand on the banking sector will continue to be higher in the coming days. This reiterates the need for improved efficiency of the sector. This has become important also due to the fact that the global regulatory environment is becoming tighter, the global economic environment facing more volatility and resources are becoming scarce. There will be demand for higher capital and skilled human resources for smooth functioning of banks and for ensuring compliance in the future. Hence the banking sector in Bangladesh will have to focus on using both its financial and human resources in a far more innovative, judicious and efficient way to cater to the future demand. 
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The writer is Research Director at Centre for Policy Dialogue and currently a Fulbright Scholar at the Earth Institute of Columbia University, New York.