Regulatory forbearance fuels banks’ capital

The banking sector's capital base got stronger in the third quarter this year thanks to the regulatory forbearance provided by Bangladesh Bank.

As of this September, the average capital adequacy ratio (CAR), which determines the adequacy of a bank's capital in keeping with their risk exposure, stood at 11.94 per cent, up from 11.63 per cent three months earlier and 11.65 per cent year-on-year, according to central bank data.

Four state-run and six private banks enjoyed a regulatory forbearance of Tk 17,194 crore, which, they were supposed to set aside as provisioning against their defaulted and regular loans between July and September.

Bangladesh Bank had earlier allowed the lenders to keep the provision in phases due to their fragile financial health.

Facilitating regulatory forbearance is not a solution though, as this just helps hide the actual crisis in the banking sector, for the time being, experts said.

The central bank should refrain from offering such facilities as the practice has hurt the sector, they added.     

This ultimately led to an artificial increase in the banking sector's CAR, according to an assessment by Bangladesh Bank.

Regulatory forbearance is when the regulator refrains from exercising its right to put an insolvent bank out of business.

Banks have to keep provisioning ranging from 0.25 per cent to 100 per cent based on the quality of their assets (loans and advances) to absorb shocks emerging from the credit, operational, market and other risks.

Had the banks not secured the regulatory forbearance, the actual CAR would have stood at 10.39 per cent in September 2020.

Four state banks -- Sonali, Janata, BASIC and Rupali -- failed to manage the required capital despite getting the forbearance from the central bank.

Agrani, Bangladesh Krishi and Rajshahi Krishi Unnayan banks also faced capital shortfalls in the third quarter.

In addition, Bangladesh Commerce Bank, ICB Islamic Bank, Padma Bank and the National Bank of Pakistan were unable to maintain the required provision.

The 11 banks collectively faced a capital shortfall of Tk 19,298 crore as of September.

"The central bank should force the lenders to keep the required provisioning at any cost in the interest of the financial sector," said Ahsan H Mansur, executive director of the Policy Research Institute of Bangladesh.

"Both the country and the globe are now in an economic hardship due to the coronavirus pandemic. Banks will have to increase their provisioning as a part of their efforts to tackle a potential financial problem," he said.

However, there is little scope to fortify the capital base of the state lenders due to a lack of corporate governance.

Disbursing loans through state lenders frequently leads to corruption and recovering the fund from delinquent borrowers is highly difficult, said Mansur, also a former high official of International Monetary Fund.

"Arresting defaulted loans is the main arm to strengthen the CAR, but this is a very tough job for state lenders," he added. 

Injecting capital from the exchequer is the only option to protect the state banks in this regard.

This means that public money has to be spent to protect state lenders from their precarious situation that stems from corruption.

"The government may not allow state-run banks to give out loans to borrowers. They should be allowed to lend only to private banks, meaning that the lenders will act as deposit banks," Mansur said.

He went on to suggest that the private banks, which have repeatedly failed to manage capital, should be merged with stronger lenders.

Salehuddin Ahmed, a former central bank governor, said the increase in the CAR in September did not reflect the actual situation of the banking sector.

Bangladesh Bank will have to tackle the defaulted loans to strengthen the capital base in banks genuinely, he said.

Defaulted loans in the banking sector stood at Tk 96,117 crore as of June in contrast to Tk 94,313 crore at the end of 2019.

The central bank should monitor the beleaguered banks on a one-to-one basis, Ahmed said.

"But there are many challenges to improve the capital base in the state lenders due to their involvement in widespread corruption," he added.

The capital base of Bangladesh's banking sector is much weaker than its peer countries, according to the central bank's latest financial stability report for 2019.

For instance, Pakistani banks kept their CAR at 17 per cent while it was 16.5 per cent in Sri Lanka by the end of December last year. As of September 2019, the CAR in Indian banks stood at 15.1 per cent.