Sketch by Dr Sadiq Ahmed / TBS
Sketch by Dr Sadiq Ahmed / TBS
The deregulation of the banking sector and the gradual tightening of prudential regulations between 1998 and 2011 significantly enhanced the performance of the banking sector in Bangladesh, which contributed significantly to positive development outcomes. The deregulation campaign ushered in a vibrant and competitive private sector banking enterprise that changed the banking landscape in Bangladesh.
The predominance of a corrupt and inefficient public bank has given way to a private bank which has mobilized an enormous amount of financial resources to support the investment and working capital needs of a burgeoning private sector. Competition for deposits and loans has resulted in rapid improvements in banking services for depositors and borrowers. A gradual tightening of prudential standards has improved the banking sector’s loan portfolio, thereby improving its financial health.
However, this progress has slowed down after 2011 and more recently has faced substantial downside risks which, if not taken into account for an extended period, could cause serious problems for the health of the banking sector. The latent problems in the banking sector are reflected directly in the growing incidence of non-performing loans (NPLs). The value of NPLs increased from Tk 226 billion in 2011 to Tk 961 billion in 2020 (Figure 1). As a percentage of the total loan portfolio, nonperforming loans increased from 6.1% in 2011 to 10.3% in 2018, and then declined slightly to 9.2% in 2020.
The slight downward trend in NPLs as a percentage of total loans after 2018 is not based on any significant reform and therefore does not reflect an improvement in the financial health of the banking sector. Unfortunately, the government chose not to meet the challenge of the deteriorating banking sector loan portfolio by introducing lasting reforms but opted for cosmetic actions to mask the scale of the real problem.
Actions to address non-performing loans have mainly consisted of relaxing loan classification standards, restructuring large loans and massive loan cancellations. These policies have reduced the stock of NPL somewhat, but the fundamental problems that gave rise to NPLs – bad loan decisions and poor application of loan collections – remain largely untouched. So, while the stock of NPLs cosmetically decreases, the flow of new bad loans continues to grow. This flow problem has been further aggravated by the appearance of Covid-19.
A particularly damaging element of the cosmetic approach to reducing the stock of NPLs is the issue of loan cancellations. While it may seem like the right thing to do to keep the books of the banking sector clean since these loans would never be clawed back, it is not clear that the government has paid enough attention to the social cost of this policy. The volume of loan cancellations since 2008 is shown in Table 1. The annual amount of loan cancellations has gradually increased due to the increase in non-performing loans. Loan cancellations continued to be dominated by public sector banks until 2017. As of 2018, private banks account for a higher share of total loan cancellations, reflecting the growing portfolio problems of private banks.
The social cost of forgiveness is substantial, but these costs differ between public and private banks. For public banks, the social cost of loan cancellations is enormous because it amounts to either a misappropriation of taxpayer income or a loss of income for public banks. Basically, loan write-offs from public banks are simply a reflection of the shifting of the burden of bad debts to the Treasury, which then funds loan write-offs from taxpayer resources or by foregoing income transfers from public banks.
These divert resources from high priority spending such as health, education and social protection to borrowers of these funds from public banks. This critical point is highlighted in Table 2, which tells a very sad story. Annual write-offs from public banks have greatly exceeded total health expenditure in all years from FY2010 to FY2020. Most years they have also exceeded the amount spent on social protection (excluding pensions). civil service).
The social cost of public bank write-offs is obviously very high. These resources could have been put to good use to improve the health status of the Bangladeshi population and reduce poverty through income transfers to the poor and vulnerable. Instead, the money mostly went into the pockets of the rich and powerful borrowers of the public sector banks who took the money and never paid back the interest or the principal or both. This practice is highly unethical and socially harmful and must be stopped.
The social cost of canceling private bank loans is less devastating but also damaging. High NPLs and associated loan cancellations tend to increase the cost of financial intermediation, which invariably puts pressure on interest rates as banks attempt to recoup their income from higher lending rates. and at lower deposit rates. They also affect the quality of banking services by reducing administrative costs.
In a market economy, business losses can occur. For example, a deterioration in the business environment, as has happened in today’s Covid-infected world, can hurt business revenues. Evidence shows that private companies globally have suffered revenue losses. Governments around the world have stepped in by shielding businesses from these losses through a series of fiscal and monetary stimulus packages. Yet some banks have also likely lost revenue from Covid-induced NPLs. Thus, a certain amount of NPL and loan write-offs is part of banking business globally. But good banking practices limit these losses, as evidenced by the experience of private foreign banks operating in Bangladesh which have very low NPLs and a tiny number of loan write-offs.
It is no coincidence that private foreign banks have the best loan portfolio, as lending decisions are primarily based on customer quality considerations. On the other hand, public banks have the poorest portfolio quality while a growing number of weak and poorly managed private banks are also experiencing growing portfolio problems. A common feature of these banks is bad lending decisions due to bad governance. The only sustainable way to reduce loan cancellations is to stem the tide of bad lending decisions through marked improvements in bank governance where lending decisions are guided by project quality and not by political connections. or commercial. Likewise, the loan recovery process should be guided by established business standards and not by ties.
In the short term, the Bangladesh Bank, as the main banking supervisory agency, must adopt a swift program to stem the flood of bad debts through much stricter supervision and disciplinary action against the management of poorly functioning banks. . Frequent loan write-offs and a relaxation of loan classification should be avoided.
The Ministry of Finance should not get involved in cosmetic NPL solutions or provide policy cover to defaulting debtors. It should strengthen the hands of the Bangladesh Bank by giving it greater autonomy, including the application of comprehensive prudential standards for public banks.
In the longer term, public banks must either be privatized, converted into narrow banks, or given full autonomy to operate as profitable enterprises with a severe budget constraint that essentially prevents transfers from the treasury. Weak private banks must be given a time frame to fully implement and comply with all prudential standards, failing which they become candidates for mergers. The legal framework for loan recovery needs to be strengthened. Good management of the NPL stock should be adopted on the basis of international experience of good practice.
Sadiq Ahmed, Vice-President, Bangladesh Policy Research Institute