Published on The Financial Express
Fahmida Khatun in the first of a three-part article titled ‘State of governance in the banking sector: Dealing with the recent shocks’
The banking sector is one of the most important components of the financial system that mobilises resources for productive investments in a country which in turn contributes to economic development. The banking sector in Bangladesh has flourished during the last three decades or so as a result of increased demand of the growing economy. During this period, the banking sector has also undergone several reforms and fallen under the jurisdiction of a number of acts in a bid to improve the efficiency of the sector.
Nevertheless, the sector is yet to improve its performance in terms of trust and confidence of people as shocks hit the sector from time to time in a major way. Among these, the issue of governance in the banking sector has currently been under the spotlight in the context of the Hall-Mark scam which has been the biggest financial crime in the history of Bangladesh’s banking sector. Given the contribution of the banking sector to the overall development of the country, such processes of misappropriating public resources can have serious implications for economic growth of the country.
Here some of the challenges confronting the banking industry of Bangladesh, particularly focusing on the state-owned commercial banks (SCBs) in view of the Hall-Mark case will be discussed. Also a number of key recommendations will be made for a healthy banking sector and to prepare for the emerging challenges.
Overview of the banking sector: In Bangladesh, the financial sector is dominated by banks. In terms of share in the gross domestic product (GDP), total asset of the banking sector was 65.5 per cent of GDP in 2010 and of non-bank financial institutions (NBFI) 3.4 per cent of GDP in June 2011, asset of the capital market was 33.7 per cent of GDP in April 2012. The pace of development for the banking industry has been significant over the past decades. In calendar year (CY) 2011, the total asset of 47 commercial banks stood at Tk. 5874.90 billion (5,87,490 crore) and deposit at Tk. 4509.80 billion (4,50,980 crore). During the last ten years (2001-2011) the total asset has grown by 324.2 per cent while deposit has increased by 326.9 per cent. Total deposit is currently 51 per cent of GDP of the country. The ratios of money supply (M2) to GDP, total deposits to GDP and total domestic credit to GDP have shown a steady increase over the years, indicating an increased financial depth. In comparison to other South Asian countries, Bangladesh stands behind India and Nepal. (Table 1).
Financial inclusion, though still low compared to developing countries, has increased significantly since independence. Population per bank branch has improved from 57,700 in 1972 to 17,660 in June 2011 indicating that a large number of people are under the coverage of banking services. However, there is still a large untapped market for the banking industry as a large number of people remain outside the banking services.
The soundness of the banking sector, which basically reflects the quality of performance of the sector, is measured by indicators such as capital adequacy, asset quality, management quality, earnings, liquidity and sensitivity to market risks (CAMELS). In 1996, Bangladesh Bank adopted Basel I replacing the liability-to-capital approach with the risk-based capital approach which was adopted in 1991. The minimum capital requirement (MCR) was 8.0 per cent of risk weighted asset (RWA) with 4.0 per cent core capital. In 2002, MCR was raised to 9.0 per cent of RWA with 4.5 per cent of core capital. In line with Basel II requirement, to measure capital adequacy banks have now adopted the Basel minimum capital requirement in a phased manner. Accordingly, during January 2010 to June 2010 the minimum capital of banks was 8.0 per cent of RWA with core capital equal to 4.0 per cent of RWA; for the July 2010 to June 2011 period these rates were 9.0 per cent and 4.5 per cent respectively. Since July 2011, the minimum capital of banks should be 10 per cent of RWA with core capital equal to 5.0 per cent of RWA.
In the recent past, the situation of banks in terms of capital adequacy has improved and banks in Bangladesh have been able to maintain adequate RWA capital (Table 2). The percentage share of non-performing loans (NPL) to total loans has reduced dramatically during 1997 to 2011. Similarly, there were improvements in the case of bank management, profitability and liquidity. However, a disaggregated performance of these indicators for different categories of banks shows that the performance of the state-owned commercial banks (SCBs) has been weaker than other categories of banks in terms of CAMELS rating.
Even though there have been improved performances, the SCBs continue to beset with problems of inefficiency and solvency. Thus the seemingly good performance does not capture the reality which raises elements of doubts as regards the real health SCBs.
Reforms in the banking sector: The improved performance has been due to mainly several reform initiatives undertaken since the 1980s which aimed to liberalise interest rate, enhance the capacity of loan classification and provisioning, capital restructuring and risk analysis, strengthening central bank and improving the legal system and framework for loan recovery.
The government of Bangladesh (GoB) played an active role in the economy as it envisaged a socialist economy after independence in 1972. As a result, the government had a greater involvement in various sectors of the economy including banking and finance. The commercial and specialised banks were under the control of the government. The government embarked on a policy of liberalisation, through denationalising the nationalised commercial banks (NCBs) in the 1980s. In view of the deteriorating 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 NCBs 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 (WB) and the International Monetary Fund (IMF). 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 WB. The Commission pointed out, among others, problems relating to the supervisory task of Bangladesh Bank, overall structure of the banking sector and pointed out that non-performing assets (NPA) required improvement. The consequent Financial Sector Reform Programme (FSRP) and Financial Sector Adjustment Credit (FSAC) carried out in the 1990s were geared towards implementation of various reform measures in the financial sector.
Following the phase-out of the FSRP 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 national parliament in 2003 to bring more reforms in the banking sector. The 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 also to formulate the monetary policy. The WB and the government of Bangladesh (GoB) undertook a reform initiative called the Central Bank Strengthening Project (CBSP) 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 such as (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 SCBs into limited companies and restructuring of three SCBs in 2007 to operate as more of a commercial entity. Supported by the WB and monitored by Bangladesh Bank, the reform initiative included measures such as selection of the Chief Executive Officer (CEO), Deputy Managing Director (DMD) and four General Managers (GMs) of the SCBs through a competitive process and fixation of the compensation package that was commensurate with the private sector and in accordance with respective performance records. The monitorable goals were set for cash recovery of non-performing loans (NPLs), limits on new NPLs, operations, computerisation, income and profitability, increased net worth and disclosure.
Since the corporatisation of the SCBs there have been some improvements in terms of achievement of the goals that were set out. The SCBs, for the first time, did earn profit in 2008 which they also continued afterwards. The NPL has reduced and the management performance has also increased which is reflected through lower expenditure-income ratio.
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 been featured prominently in the recent years in several banks including the SCBs. This only suggests that reform is still an unfinished agenda in the banking sector of Bangladesh.