Originally posted in The Business Standard on 14 December 2023
Harsh reforms must to reverse elite capture of banks
A deliberate negligence and abuse of the banking sector has put the entire economy under extreme stress, and stringent reforms need to be taken immediately to come out of the situation, warned economists and bankers.
They have also urged the government to establish a banking commission promptly after the election to formulate a comprehensive strategy for financial sector reform.
“If the government cannot do that [address these issues and establish a banking commission], it risks a self-destructive trajectory for Bangladesh similar to Sri Lanka’s,” said Dr Ahsan H Mansur, economist and executive director of Policy Research Institute (PRI).
The economists were speaking at a Focus Group Discussion hosted by The Business Standard at its conference room on (10 December) Sunday, as part of a series celebrating the newspaper’s fourth anniversary.
Debapriya Bhattacharya, a distinguished fellow at the Centre for Policy Dialogue (CPD) said that it was the politicisation of the economy that destroyed the banking sector.
“The story of the banking sector is now the story of elites capturing the sector and rise of untouchable defaulters. A lack of accountability and regulatory failure has taken over,” he said.
Pointing out the lack of political will to address the woes of the banking sector, he said, “The political will to address imbalances within the banking sector has gotten significantly diluted within the ruling party over time. This commitment has become less specific, less concrete, and undeniably less bold”.
“This shift reflects the political economy at play,” he argued.
Dire state of banking sector
Debapriya Bhattacharya said political issues are responsible for the dire state of the banking sector.
“While last year I might have called the banking sector ‘dysfunctional,’ I now describe it as being in a ‘very dismal state.’ The deterioration is ongoing, and unfortunately, the issue has become politicised,” Debapriya said.
“Many of us are hoping for positive change after the 7 January 2024 elections. Unfortunately, I see very little opportunity for that. Powerful interest groups and individuals are hindering progress,” he said, adding that the government’s ability to implement reforms is hampered by its lack of will.
“Without breaking the cycle of power play, we cannot realistically expect any new government, regardless of its constitutional mandate, to solve our problems immediately,” Debapriya said, adding that ultimately, a political economy without the power inevitably leads to an absence of accountability.
Debapriya highlighted observations by the governor of the Central Bank of Sri Lanka, emphasising the dangers of taking additional loans to repay existing debts. He warned that this practice creates a vicious cycle of loan repayment and worsens debt issues.
“We are, unfortunately, doing exactly that,” he said.
Another critical issue is the independence of the regulating body, particularly the central bank, which bears the primary responsibility for overseeing the financial sector’s sound conduct. The Sri Lankan governor’s recent remarks highlighted the importance of genuine, not merely paper-based, central bank independence, he said, adding that ultimately, the regulator’s independence hinges on the individual’s mindset and their ability to uphold professional and technical autonomy.
“That is why the Sri Lankan central bank governor received an A grade, we here in Bangladesh received a D grade [in the Global Finance ranking],” he said.
Bangladesh Bank Governor Abdur Rouf Talukder was given a D grade as a governor in a ranking by New York-based Global Finance magazine due to the country’s high inflation and devaluation of the taka.
“Just a year ago, Bangladesh and Sri Lanka were in similar positions. Yet, while Sri Lanka has shown signs of recovery, we have fallen further behind,” Debapriya said.
The economist identified three primary reasons for Bangladesh’s lagging performance: A weakening political commitment, the central bank’s failure to implement corrective measures, and the detrimental influence of the political economy.
He elaborated on how recent amendments to the Banking Company Act favouring sponsor directors have eroded corporate governance within the private sector.
Debapriya further mentioned the inability of citizens’ movements, including depositor groups, to generate sufficient pressure and effectively counteract the takeover and elite capture of the banking sector.
An objective strategy
Underlining the need for urgent measures, Dr Mansur said, “A deliberate negligence and abuse of policy everywhere including the banking sector, fiscal management, exchange market management, macroeconomic management, inflation control, dragged down the entire economy to a state that the government cannot survive for long with as usual business strategy.”
Suggesting concrete measures the government should take, Dr Mansur said,”Immediately following the election, the government must undertake a comprehensive financial sector reform, addressing the underlying political economy. This is essential to overcome pressure groups, ensure its own survival, and ultimately, salvage the economy,”.
Quoting Sri Lankan politician Mahinda Rajapaksa’s words about his family’s immense power and control, Mansur said no government can withstand an economic crisis. He urged the government to learn from Sri Lanka’s plight and take immediate action to restore the banking sector’s stability.
However, he expressed scepticism regarding the government’s ability to implement necessary reforms. His concerns centred around potential resistance from future regimes and the enduring influence of vested interests within the government.
Only by escaping the influence of pressure groups and adopting an objective strategy can the government ensure its own survival, Dr Ahsan Mansur added.
Strong corporate governance for discipline
Syed Mahbubur Rahman, managing director of Mutual Trust Bank, stressed the resolution of non-performing loans (NPL) and said “Ensuring strong corporate governance is crucial to discipline banking. We need to take action independent of political influence and hold all defaulters accountable, regardless of their status. Resolving the NPL problem is critical to improving the efficiency and stability of the banking sector.”
Mahbubur Rahman said the imposition of a lending rate cap and the lack of a market-driven exchange rate have had a significant negative impact on the economy.
He said banks were against the lending rate cap imposed in 2020 as real industrial growth in Bangladesh occurred when the lending rate was higher. So interest cost is not very important for investment growth.
“Another major challenge has been the foreign exchange rate, which has severely impacted our economy. Between 2011 and 2021, the taka depreciated only 14% from Tk75 to Tk85, while India saw a 75% depreciation in their currency during the same period,” said the seasoned banker.
“We failed to adequately appreciate the significance of the exchange rate and mistakenly viewed the taka’s limited depreciation as a badge of pride. This misplaced focus has ultimately crippled the banking sector,” he said.
Echoing the concerns raised by the International Monetary Fund, he warned that delaying the implementation of market-driven lending rates and exchange rates will prolong the economic woes.
“While the central bank’s recent policy rate hike is a welcome move, it comes at a time when the harm is done. Although better late than never, the increased liquidity costs for banks have led to a significant rise in treasury bills and bond rates. This has shifted banks’ preference towards holding government bonds instead of lending,” the Mutual Trust Bank MD added.
Financial inclusion, insurance
Arfan Ali, former managing director (MD) of Bank Asia, said the main way to solve the crisis in the banking sector is to ensure robust and impartial implementation of the law.
However, around 70% of lawmakers in the parliament are businessmen. This concentration of political power within the business community creates a conflict of interest, hindering effective regulation and potentially hindering the fair enforcement of the law, he said.
The banker called for increased insurance penetration in the financial sector. With a meagre 1% insurance coverage compared to India’s 4%, Bangladesh has a vast potential to expand access to financial protection and security for its citizens, he said.
Arfan argued that Bangladesh Bank’s policy of regularly rescheduling classified loans needs a gradual phase-out.
“This practice hinders the creation of new entrepreneurs as existing borrowers repeatedly get loans. Additionally, we must focus on increasing the tax-to-GDP ratio, which currently stands below 10% and needs to reach the 18-20% range.”
Focus on small loans
Professor Prashanta Kumar Banerjee of Bangladesh Institute of Bank Management (BIBM) emphasised the need for long-term loans to be financed through equity and bonds, noting that this practice is currently absent in the country. He argued that adopting this approach would reduce pressure on banks.
He also said banks should shift their focus from large loans to small loans to support small businesses and promote economic development.
“To enhance good governance in the banking sector, the central bank could create a pool of qualified independent directors. Commercial banks would then select directors for their boards from this pre-vetted pool,” Prashanta Kumar added.
A bad practice
Dr Birupaksha Paul, former Bangladesh Bank chief economist and professor of economics at SUNY Cortland, US, advocated for ending the practice of loan rescheduling to address the non-performing loan (NPL) problem.
He said borrowers, aware of the possibility of repayment extensions after defaulting, take loans with less intention to repay, leading to a stagnation of bank capital.
Dr Paul also emphasised the need for increased transparency within the Bangladesh Bank Board arguing against closed-door meetings and advocating for greater media access to Board proceedings.
Additionally, he urged the central bank board to eliminate the practice of selecting board members based on political expediency or personal connections and instead of the usual practice he advised for a meritocratic and transparent selection process.
“Policy inconsistency creates moral hazard. The governor announced a free-float exchange rate regime in the current monetary policy, but now he is saying that it is not possible to implement the policy. Such inconsistency in commitment and action creates chaos in the financial sector,” he said.
Pressure groups
Addressing the impact of pressure groups on the government, Dr Ahsan Mansur mentioned the controversial amendment to the Banking Company Act. This amendment extended the tenure of bank directors from nine to 12 years. This change, he commented, raises concerns about undue influence and potentially weakens corporate governance within the banking sector.
He also expressed optimism for positive developments, noting the central bank governor’s acknowledgement of the need for action after the election and his commitments to the IMF.
Ahsan further recommended the immediate formation of a post-election Banking Commission to spearhead a comprehensive reform strategy for the sector. This commission should comprise experts both from within and outside the government, fostering open and transparent dialogue with stakeholders.
Additionally, the inclusion of international best practices and expertise would be invaluable, he concluded by emphasising that the government’s commitment to this initiative would serve its own long-term interests.