Originally posted in The Daily Star on 19 August 2024
In a welcome move, the Bangladesh interim government intends to establish a banking commission soon to introduce crucial reforms in the banking sector. This initiative is a response to our long-standing demand for taking meaningful measures to rescue the financial sector from inadequate governance.
It is unfortunate that the previous government fell short of its commitments to strengthen the banking sector, as outlined in various policy documents and strategic plans. This lack of action has left the sector exposed to increasing vulnerabilities.
Institutional challenges in the banking sector include the appointment of bank directors often influenced by political connections, loans granted for political reasons, the rescheduling of loans despite poor repayment records, writing off loans to reduce tax burdens and clean bank balance sheets, weak internal controls, inadequate compliance and risk management, and the failure of some banks to meet international standards.
Additionally, regulatory weaknesses have contributed to the sector’s vulnerability. These include the lack of independence of the Bangladesh Bank, overlapping regulations by the Financial Institutions Division (FID) and the Bangladesh Bank, leniency towards defaulters by the Bangladesh Bank, arbitrary issuance of bank licenses to crony capitalists, government-led recapitalisation of banks, and the quasi-monopolistic power held by a few bank oligarchs.
The most alarming indicator of the banking sector’s fragility is the substantial increase in non-performing loans (NPLs) accumulated over the past 15 years, exacerbated by both direct and indirect support from the previous government’s policymakers. In 2009, NPLs in banks totalled Tk 22,480 crore, which surged to about Tk 1,82,000 crore by March 2024. The true extent of NPLs would be considerably higher if distressed assets, loans in special mention accounts, loans under court injunctions, and rescheduled loans were included.
High NPLs limit banks’ fiscal flexibility by constraining their ability to expand lending and forcing them to forgo interest income. They also reduce banks’ capacity to take on risks, leading to an increase in the cost of funds. Additionally, banks face capital shortfalls as they must set aside provisions to cover their NPLs, which in turn negatively impacts their return on assets, equity, and capital liquidity.
Often, loans were approved without proper commercial considerations, heightening the risk of defaults during the previous regime. When the central bank is not allowed to operate independently, it is more likely to make poor decisions. Unfortunately, the Bangladesh Bank was unable to penalise wilful defaulters due to the loss of its independent decision-making authority, which has been overridden by politically connected interest groups.
Given the worsening performance of the banking sector, we have consistently advocated for the establishment of a temporary banking commission to address these pressing issues. The purpose of this commission would be to thoroughly investigate and propose solutions to the challenges facing the sector. To ensure the commission is effective, its Terms of Reference (ToR) should be clearly outlined and may include the following objectives.
First, the objectives of the banking commission should be clearly defined and focused. These should include: i) conducting a critical assessment of the overall state of the sector; ii) ensuring transparency in data and information related to the sector; iii) identifying the root causes of current problems and potential future challenges; iv) determining which groups and institutions are responsible for the sector’s crisis; and (v) providing specific, actionable recommendations for administrative, regulatory, legal, and structural reforms in the short to medium term.
Second, the commission’s timeline should be concise and strictly timebound, not exceeding three to four months, to enable the government to begin implementation promptly.
Third, the commission should adopt an inclusive and participatory approach in preparing its report. This approach should include: i) conducting desk research using existing data and information; ii) holding individual meetings with relevant stakeholders; iii) consulting with experts; iv) organising public dialogues and hearings; and v) engaging in discussions with a wide range of stakeholders including policymakers, entrepreneurs, bank customers, small savers, small and medium-sized businesses, experts, bank officials, economists, representatives of banking-related organisations, women, youth, grassroots organisations, and the media.
Fourth, to ensure transparency, the commission should regularly update the public on its progress. Interim reports should be prepared and made available to citizens, and a draft of the final report should be posted online to gather feedback from stakeholders.
Fifth, commission members should be highly competent, experienced, honest, and impartial, and they must carry out their responsibilities with the utmost professionalism.
Sixth, the commission must be allowed to operate independently, free from any external influence.
Seventh, the interim government should establish a clear roadmap outlining when and how the commission’s suggestions will be implemented. The government should also be required to provide full transparency regarding the proper implementation of these recommendations and their impact on the banking sector.
The banking sector has undeniably played a significant role in expanding trade and business within the economy. In the 1980s, the government of Bangladesh initiated the liberalisation process by privatising nationalised commercial banks. This reform process continued throughout the 1990s and 2000s, guided by the directives of the World Bank and the International Monetary Fund (IMF).
Alongside these reforms, the National Commission on Money, Banking, and Credit was established in 1984. A banking commission was formed in 1996, followed by the creation of a banking reform committee in 2002. In 2003, the Central Bank Strengthening Project was initiated to develop a robust and effective regulatory and supervisory framework for the banking sector. The Bangladesh Bank Amendment Bill, 2003, which granted Bangladesh Bank autonomy, was passed by the parliament. However, despite this mandate, Bangladesh Bank ultimately lost its independence.
The recommendations for the commission can only improve the banking sector if it is allowed to operate without political interference. While the interim government is dedicated to implementing institutional reforms during its term, it must also ensure that these reforms are sustained beyond its tenure.
Dr Fahmida Khatun is executive director at the Centre for Policy Dialogue (CPD) and non-resident senior fellow of the Atlantic Council.