What’s driving the government’s U-turn on banking sector reform?

On March 1, Moody's, one of the big three global rating agencies, revised its outlook for Bangladesh's banking sector from "stable" to "negative." It also mentioned Bangladesh among the list of countries that will have a worsening state of banking operations in 2023, which is particularly concerning, given that the sector's health was already on a deteriorating trend.

Moody's explained that an increase in asset risks and tightening of the liquidity situation in Bangladesh is what prompted it to make this decision.

We already know that the Bangladesh Bank approved emergency loans for Islamic Bank Bangladesh, Social Islami Bank Limited, First Security Islami Bank, Global Islami Bank, and Union Bank worth Tk 14,790 crore in December last year. Such emergency funds are usually taken during extraordinary circumstances. And the Shariah-based banks, which do not borrow money by offering interest, had to borrow from the Bangladesh Bank at 8.75 percent interest as their cash reserve ratio (CRR) fell short of the central bank-stipulated rate for an acute liquidity crisis.

Islami Bank, which is currently under investigation by the central bank for gross irregularities over the disbursement of loans amounting to Tk 7,246 crore among nine companies, took the highest amount from the emergency fund. Reports about the investigation apparently led to a confidence crisis among depositors of the five banks, all of which have Chattogram-based business conglomerate S Alam Group well-represented in their boards.

By now, it is relatively well-known what has been happening at these banks. The massive irregularities surrounding them sums up, to an extent, the sorry state of our banking sector as a whole. The sharp rise in defaulted loans, scams, irregularities, mismanagement, lack of good governance, and the regulator's willingness to bend the rules for some – supposedly under pressure from influential quarters – at the cost of many have made it one of the most troubled sectors in the country that, in turn, has exposed the economy to unnecessary risks.

The downgrading by Moody's will only add to our economic woes. As confidence of investors and foreign institutions in the sector further erodes, it will become harder for Bangladesh to attract foreign investment – which is already one of the lowest in Asia – and make obtaining loans costlier for businesses and banks operating in the country. This may result in stressed assets for banks to rise, as businesses (to which banks have large exposure) are facing slowing external demand due to inflation in many of their key markets and rising costs due to higher import prices.

The downgrade also reflects the government's decreased capacity to provide the same unconditional – and often questionable – support for banks because of its worsening external position. This comes at a time when systemwide loan-loss reserves as a proportion of non-performing loans (NPLs) is hovering at a pretty low level of 56 percent as of September last year, which is inadequate to provide sufficient buffers against rising loan losses.

The downgrading by Moody's will only add to our economic woes. As confidence of investors and foreign institutions in the sector further erodes, it will become harder for Bangladesh to attract foreign investment – which is already one of the lowest in Asia – and make obtaining loans costlier for businesses and banks operating in the country.

Moody's, of course, has also put Bangladesh's years-long Ba3 rating under review. According to experts, should the country's sovereign rating get downgraded too, it would set our economy back by decades. The government, which has adamantly refused to reform the banking sector, is now under quite a lot of pressure, including from the International Monetary Fund (IMF), which, having granted us a $4.7 billion loan package, has expressed serious concerns about the continuing growth of bad debts and asked the government to implement various reforms. Recently, a spokesperson for the Bangladesh Bank told Nikkei Asia that efforts towards institutional reform of the whole sector were already underway and "amendment to the banking and financial laws" were also in the pipeline.

Even though the spokesperson did not specify any particular law, on March 29, this newspaper reported that the cabinet had cleared the draft Bank Company (Amendment) Act, 2023, which would initiate major consequences for habitual loan defaulters and restrict the influence of families on banks' boards. Interestingly, it was the Awami League government that had increased the influence of families in banks' decision-making in the first place, to the great detriment of the sector.

So, it seems like the government, which had refused to listen to domestic calls for reforms, is now giving in to foreign pressure. But will it go through with it?

On March 15, it was reported that, according to the latest Bangladesh Bank data, default loan rescheduling and interest waivers had increased at an unusual rate. Lenders had waived off some Tk 5,064 crore loan interests while rescheduling loans in 2022, which was Tk 3,209 crore higher than the previous year. Additionally, banks rescheduled loans worth Tk 27,279 crore in 2022, which was more than double the amount from the year before.

The benefit of the loan waiver, according to a central bank official quoted in the report, had apparently gone to large groups, instead of going to small borrowers (which would have truly benefited our economy). Meanwhile, the managing director of a private bank said this was "not the actual amount of defaulted loans" in the sector, which was still being "hidden in various ways."

Given this reality, one must ask: how does the government expect to implement proper corrective measures without bringing in full transparency? The question also remains whether the government will truly use the bank law amendment to go after habitual defaulters, who are closely connected to certain influential and political circles. As it frequently happens with all other laws in Bangladesh, it is possible that this might also fall by the wayside in the implementation stage.

However, given that more and more banks have recently started to suffer from a severe liquidity crisis, it is possible that the day of reckoning is not too far away when the government will be left with only two options: either implement serious reforms, or allow the banking sector to usher in a major crisis for the country.

Eresh Omar Jamal is assistant editor at The Daily Star. His Twitter handle is @EreshOmarJamal