Banking sector needs further reforms

The banking sector in Bangladesh has come under criticism in the recent past due to increased number of financial scams and the rising size of loan default. Undoubtedly, the size of the industry has expanded in terms of total banks and their branches, deposits and credits which in turn have contributed to the economic development of the country. The performance of the banking sector has also improved over the years according to various indications such as capital to risk weighted asset, rate of non-performing loans (NPL) to total loan, expenditure income ratio, return on asset, return on equity, and liquidity. This has been possible due to various reform measures and policy support of the consecutive governments.
Unfortunately, the health check fails to conceal the problems suffered by the sector from time to time. The current situation of large financial frauds and high NPL of banks calls for a close scrutiny of the sector and necessitates taking required measures.
The first reading of the Independent Review of Bangladesh's Development (IRBD) of the Centre for Policy Dialogue prepared in January 2013 presented a detailed analysis of the trend and the governance of the banking sector in the context of the Hall-Mark scam. This section will focus on a selected set of issues relating to some of the emerging concerns.
The soundness indicators of the banking sector performance reveal that since 2009 the overall performance of the sector has been unsatisfactory. Capital to risk weighted assets is on the decline while the percentage share of NPL to total loans is increasing. Similarly, return on asset and return on equity have sharply declined. A disaggregated scenario indicates that NPL in the state owned commercial banks is the highest among all categories of banks in Bangladesh. This is a reflection of the fact that financial malpractices such as Hall-Mark and Bismillah groups which embezzled large amount of money from SCBs have started to tell upon the health of the SCBs.
It is apprehended that there could be many more cases of forgeries which may be unearthed in course of time and pose further threats towards the stability of banking sector. Unfortunately, actions against such frauds have been slow.
High NPL pushes the interest rate of banks upwards as they try to make up for their losses from bad loans. Apart from weak monitoring and supervision of loans, the reason for high NPL is also linked to the governance issue. Given the inefficiency of SCBs, there have been propositions to privatise those, except for one which will perform the treasury activities of the government.
Within a period of five months, Bangladesh Bank has changed the rules of loan classification and provisioning. On September 23, 2012, the Banking Regulation and Policy Department (BRPD) of the central bank issued a circular with new provisions for loan and rescheduling stating, “Bangladesh Bank is concerned that rescheduling (also known as “prolongation”or “evergreening”) may sometimes result in an overstatement of capital when loans that have a low profitability of repayment are carried at full value on banks' balance sheets” (www.bangladesh-bank.org).
The new BRPD circular no 05 dated May 29, 2013 relaxed the period of rescheduling to six years instead of 4.5 years at present. The time limit for first rescheduling of a classified loan will now be 36 months since the repayment of last instalment instead of present 24 months. Additionally, time limits have been reset at 24 months and 12 months for second and third rescheduling, respectively. Loan provisioning requirement has been reduced to various levels in various sectors. According to the new circular, banks have to make provision of just 1 percent instead of 5 percent for a special mention account (SMA). The provisioning requirement will be 2 percent for housing, professional and investment banks.
While the circular does not explain the reason for such relaxation, officials and the BB told the media that these measures have been taken in view of the rise in classified loans. They also expect to create an additional Tk 500 crore investable funds for banks through these measures. Classified loans have doubled during January to March 2013 compared to the same period in 2012. Both in state banks and private commercial banks, the amount of classified loans doubled during these two compared periods. Though the BB made this move to save the loss making banks and increase the profitability of banks, this is rather a very simplistic way to assess the problems of the sector.
If one looks at the long time trend of the performance of the sector, it is clear that the state banks have consistently been underperformers compared to other players in the sector. Partly, this may be due to various services they have to provide as government owned banks. For example, the state banks have been disbursing higher agricultural credit or providing banking services to the larger section of people with limited income across the country. However, the major reason for high NPL and classified loans lies in its inherent weak mechanism to undertake banking activities by following the existing guidelines of the central bank. Hence, the new announcement is only a window dressing to show an artificial increase of bank profitability.
In FY2012, the BB followed a monetary tightening policy to reduce the inflation rate from double digit to single digit. As a result, inflation rate reduced, but at a cost. This had a negative impact on the credit flow. For example, in July 2011, credit to private and public sectors grew by 24.36 percent and 39.87 percent, respectively. In June 2012, credit to both private and public sectors reduced significantly to 19.72 percent and 25.43 percent, respectively.
Such a decline is apprehended to have an impact on the investment and growth situation of the country. In its monetary policies of FY2013, the central bank focused more on GDP growth through more productive investment and containing inflation. As a result, during the first eight months of FY2013 there has been an increase in money supply. This, however, was not accompanied by increased flow of credit.
The monetary policy statement (MPS) of the BB for the period January-June 2013 set targets at 17.7 percent for the growth of the broad money supply (M2) and 18.5 percent for the growth of the private credit. The early signals of the monetary indicators are, however, not very promising. At the end of February 2013, M2 grew by 18.9 percent as opposed to 18.19 percent in February 2012. In case of credit flows, both public and private sectors suffered sharp decline compared to the last fiscal year.
The growth of credit to the public sector was a mere 8.57 percent in February 2013 compared to 59.92 percent in February 2012. On the other hand, the flow of credit to the private sector experienced a decline from 19.55 percent in February 2012 to 13.96 percent in February 2013.
The decline of credit to the public sector signifies a lower dependence of the government on the banking system and availability of more resources with banks for the private sector. However, the slow growth of credit to the private sector is again a reflection of low appetite of the sector for credit which is mainly related to dampened investment climate of the country due to a lack of infrastructure including power and gas supply and political turmoil.
There have been policy directives by the BB favouring agricultural credit. As a result, commercial banks are mandated to disburse agricultural loans to various sectors including crops, livestock and fisheries.
However, the growth of agricultural credit during January-March 2013 is only about 9 percent compared to the same period in 2012. A disaggregated data reveal that since 2009 the share of the crop sector is consistently increasing in total agricultural credit, so is the case with livestock and fisheries. However, the allocation for poverty alleviation activities has mostly been declining. Given the ambition of supporting inclusive growth in the country, efforts towards poverty alleviation programmes demand more attention.
Excess liquidity of the scheduled banks has almost doubled during January 2012 to February 2013. The growth of excess liquidity in the banking system has influenced the money market by bringing down the call money rate significantly, from 19.66 percent in January 2012 to 8.95 percent in February 2013. The call money rate hovered around 10 percent during January 2009 to October 2010, but increased sharply to 33.5 percent in December 2010 because of the adjustment in the CRR and SLR rates by the central bank.
Throughout the FY2011, the excess liquidity in the scheduled banks was more or less stagnant, but started to rise again since January 2012. High excess liquidity is not, however, accompanied by low interest rate, as logic would suggest. In addition to low investment and consumer demand, movements in the stockmarket have also implications for the liquidity situation of the banking sector in Bangladesh. Thus the provision of putting a ceiling on the exposure on stockmarket for banks has also contributed to excess liquidity in banks in the recent period.

Commercial banks are probably trying to make up for their lower profit through high lending rates which reached as high as 13.95 percent in October 2012 and reduced slightly to 13.73 percent in February 2013. However, deposit rate, though increasing since June 2010 has been much lower than lending rates. As a result, during the whole period between June 2012 and February 2013, the interest rate spread (IRS) was above 5 percent which is considered to be a tolerable level. It is only recently the IRS is coming down due to a slight reduction in lending rate and increase in deposit rate. Thus in February 2013, the IRS reduced to 5.05 percent from a peak of 5.68 percent in February 2012.
A chronology of the measures taken by the concerned authorities in view of the huge fraudulent of resources from Sonali bank indicates that there has been very little progress in the effort towards the recovery of the money. The owner of the Hall-Mark was arrested following the commotion created after the incidence was brought to light. However, in March 2013, the managing director of the Hall-Mark Group was out in bail and applied to the government to save the 40,000 workers and their families working in various factories of the Group which also houses some equipment worth Tk 500 crore.
Consequently, the finance ministry advised Sonali Bank to prepare a document advising on how to regularise debts of the company and restart this factory. However, the ministry denies that anyone related with the graft will be freed of their charges.
As of May 2013, no action was taken against Sonali Bank for the financial scam of Hall-Mark which involved an amount of Tk 3,648 crore. There has also been no trace of the money which was appropriated through unauthorised loans and advances by the said company in connivance with bank officials. The BB froze the accounts of the owner and relatives of the Hall-Mark and retrieved Tk 30 crore. The finance minister informed the parliament in April 2013 that Tk 405 crore was realised from the Hall-Mark Group so far.  According to the BB, the Anti Corruption Commission is responsible for tracing the money back.
The ACC is seeking account information of officials and relatives of the Group from the central bank. In February 2013, a six-member team of the ACC interrogated top officials including a former member of the board of directors of Sonali Bank, who allegedly took bribes amounting to Tk 3 crore from Hall-Mark to sanction the loans in favour of the company.
Several names of high officials of Sonali Bank and an adviser to the prime minister came up from unofficial sources as accomplices to this fraud.  The ACC requested the former chairman, eight members of the board of directors, and two high officials of Sonali Bank, to submit their wealth statements to the commission by April 2013.
The recent trend in the banking sector is not supportive to a sustained economic development as it is encumbered with inefficiency and malpractices. The accumulation of excess liquidity is not only a reflection of low demand for funds. It also indicates weak supervisory and poor portfolio management of commercial banks. Several malpractices of commercial banks have also contributed to the weak performance of the banking system. In view of this, there should be further reform measures to streamline the activities of the sector towards improving its performance.

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