Neither A Borrower nor A Lender Be

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How much trouble is the banking sector in

Every year, the World Bank Group releases its annual review, known as Bangladesh Development Update, of the country they are operating in. The report is prepared by leading economists of the country with utmost care to provide the most realistic expectations for an economy. And give an unbiased view of what can be done better. Fortunately for Bangladesh, the country is experiencing the joys of being in the limelight after toiling for years to achieve growth rates which are greater than 7%. Hence the World Bank’s annual review report had a greater number of positive news to share than negatives.

However, a lingering fear exists regarding the banking sector of the country. A rising number of non-performing loans (NPLs), dipping lending rates and botched attempts as debt servicing has eroded the credibility of the banking sector of the country’s economy. In fact, one of the worlds best rating agencies, Moody’s has put Bangladesh’s banking system on ‘negative watch’ in their report due to worsening assets quality. Two other global rating agencies- Standard & Poor’s and Fitch- also expressed concerns over the health of the banking sector of Bangladesh.

Data Doesn’t Lie
It seems like the quality of the bank assets is not its only concern. The growth in bank credit has moderated while the NPLs have ballooned. Banks’ return on assets (ROA) narrowed by 57% in 2018, as a result of the high amount of non-performing loans (NPLs) in the sector. ROA is a profitability ratio that provides information on how much profit a bank is able to generate from its assets. The higher the number, the more efficient a bank’s management is at managing its balance sheet to generate profits. In 2018, net profit of banks stood at only Tk0.30 against assets worth Tk100, down from Tk0.70 per Tk100 of assets in 2017, according to the Bangladesh Bank. In 2018, state-owned commercial banks lost Tk1.30 against assets worth Tk100. In 2017, these banks had made profits of Tk0.20 against assets worth Tk100. On the other hand, private commercial banks made a net profit of Tk0.80 per Tk100 of assets last year.

When Bangladesh Bank officials are asked the reason behind the worsening ROAs they are quick to point their fingers at unscrupulous businesses which have failed or are unwilling to return the money they have borrowed from banks. However, the World Bank annual review reports that the problem is with the governance structure itself. Corporate governance weaknesses, especially at state-owned banks and legal complexities in contract enforcement are sinking the banking sector of Bangladesh. South Asian Network on Economic Modeling (SANEM), a local think-tank has said the country’s banking sector was on the wrong path, causing the economy to bleed and believes that the frail banking sector could be a huge hindrance to achieving the Sustainable Development Goals 2030 and other targets.

Why YOU Should Be Concerned About NPLs
NPLs is a sum of borrowed money upon which the debtor has not made the scheduled payments for a specified period. Banks operate as financial intermediaries. Bank owners put up a minimally required amount as equity or capital that then allows them to mobilize deposits which are loaned out. Banks offer depositors a return on their deposits (average deposit rate) and charge borrowers a loan rate (average lending rate).

A loan becomes NPL when the borrower is unable to pay the scheduled principal and interest for more than 90 days. As the size of NPL grows the financial health of the banking sector weakens because it reduces its ability to earn a profit, increase capital base and repay depositors. When the NPL problem grows very large, it could jeopardize the entire banking sector through bank failures and liquidity crisis.

The NPLs at the end of 2017 was TK743 billion and reached TK39.1 Billion by the end of 2018. It was 10.4 percent of total outstanding loans. There are two points to note: one is the upward trend in NPLs as a percent of total loans and the other is the growing size in value terms. In fact, the World Bank states that the NPL has grown by 26.4% in 2018, a growth which has been the highest in 5 years. Either way, on both counts, NPL is a major threat to the financial health of the banking sector and the government’s concern to address this threat is well placed. This is shown below:

Here’s another interesting fact about the NPLs; they are not evenly distributed amongst the private commercial banks (PCB) and the state-owned banks. In fact, 5 banks are responsible for half of the total NPLs. World Bank has reported that the NPL of State-owned Commercial Bank (SCB) is 31% and State-owned Development Bank (SDB) 22%. To think that state-owned banks would have such high NPLs isn’t surprising given that they suffer from severe weakness in corporate governance, poor risk management and often resort to direct lending.

Why Write-Offs Are NOT the Answer
Dr. Selim Raihan, Executive Director for SANEM, is amongst some of the esteemed figures who are opposed to the government’s tactics to write-off loans. Expressing frustration, Dr. Raihan said the situation in the banking sector would be at its worst if the government eventually relaxes the definition of defaulting loans, and loan rescheduling policies to favor bank defaulters.
Banks write off bad debt that is declared non-collectible (such as a loan on a defunct business, or a credit card due that is in default), removing it from their balance sheets. The result is a reduction in the value of an asset or earnings by the amount of an expense or loss for the bank.

Bangladesh Bank has granted a huge waiver for loan defaulters to expedite debt servicing in the banking sector. Experts, however, criticized the latest policy given effect through two separate central bank circulars. A circular issued by Bangladesh Bank on February 2019 allows banks to

· Write-off loans that remain classified as bad debt for three years instead of the previous five years
· Write-off bad loans up to TK200,000, instead of the previous TK 500,000, without filing any lawsuit
· Write-off loans without keeping 100% provisions

A similar circular was released in May 2019, which focused on lowering down payments, extending the loan repayment period and other special features such as ‘One Time Exit’ facility. The latest directive of the central bank says defaulters can regularize their bad loans now by paying only a 2% down payment, instead of 10-50%.

Rescheduling of loans has allowed defaulters to repay their rescheduled loans within the next 10 years, with a one-year grace period, according to the circular. The rescheduled loan would have to be repaid at only 9% interest rate and the central bank in the circular said banks could waive all interest for defaulters, depending on the bank-client relationship. And if that wasn’t enough, defaulters can enjoy a ‘One Time Exit’ facility by paying only the bank’s cost of funds and the principal loan amount. To avail the facility, defaulters have to pay the outstanding amount within a year.

So while it might help wipe the slates clean and bolster the balance sheets for the bank, it possibly sends the wrong signal to the borrowers who are defaulting and could contribute to the already poor NPL collection efforts. Toufiq Ahmed Chowdhury, Director General of Bangladesh Institute of Bank Management is of a similar opinion. He has stated that the new waivers not only cast a shadow on the banking sector of Bangladesh, it undermines confidence in the banking sector and discourages good borrowers from repaying their loans.

What’s with the Lending Rates?
Lending rates have remained rigidly on a downward trend. In June 2018, the Bangladesh Association of Bankers (BAB), a forum for the owners of private banks, suggested to fix the lending rates at 9% and deposit rates at 6% respectively. However, the banks have struggled to keep the lending rates low. The saving instruments offered by the government, the National Savings Directorate Certificates offers double-digit interest rates and thus it is more attractive for households to invest in rather than the ones being offered by private banks at the BAB rates. It was estimated that the government was likely to borrow about TK13,000 Crore from banks in December, which would have made the money market tighter and adding to the liquidity crunch.
The interest rate on lending, however, is on the rise amid high import pressure and hunt for deposits at the end of last year. Though the average remained within single digits, 28 out of the 40 private banks are lending at interest rates which are in double digits. Given that the money market is tight and there is a persistent liquidity crunch, such high numbers are to be expected. This is shown below:

What’s Next Then?
Bangladesh is adding to its growing list of private banks. For most countries, a growing list of commercial banks signifies good tidings. It is an attestation to a growing economy and abundance of funds which requires some efficient financial institutions to manage. Unfortunately, in Bangladesh, it does less to inspire hope in the financial sector and harks the possibility of greater fund mismanagement.

Furthermore, in order to become an upper middle-income country by 2031 and achieve high-income country status by 2041, Bangladesh will require huge investments in physical capital, human capital, and innovation enabled by reforms in areas such as financial sector, business regulation, and addressing the infrastructure gap.
Massive reforms are needed to fix the banking sector of Bangladesh. Bangladesh Bank has formed several committees, including a high profile one led by its one deputy governor, in a bid to reform the country’s ailing banking sector.

The committees have been tasked with making specific recommendations to reduce default loans and take actions against willful defaulters, said a senior central bank official. Furthermore, the committees will also recommend amending the Bank Companies Act, Ortho Rin Adalat (Money Loan Court), the Financial Institutions Act, and other bankruptcy-related legislation. These and many other activities will be undertaken by the committee to rev up the banking sector.

While such efforts are commendable, historically government formed committee is slow to act. And for a fast-paced sector such as the banking sector, failure to act at the correct time can be a very expensive mistake for the entire country. The answer, therefore, lies, in giving Bangladesh bank greater independence and authority to take actions when needed and uphaul the financial laws that govern the banking sector.

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