Bangladesh is one of the fastest growing economies in Asia-Pacific. The country is aspiring to gain the status of a middle income country very soon and has been making great strides in terms of social, economic and technological transformation. It recorded a commendable GDP growth rate of 7.86% in 2018. All these being said, a growing economy like Bangladesh is expected to to have high private sector credit growth, high investments, a vibrant stock market and a dynamic financial system; however, the financial system has been on a downward trend since the first quarter of 2018.
The financial sector of Bangladesh is undergoing liquidity crunch owing to a number of demand and supply side factors. Alongside, governance issues within the banking system have contributed to high levels of non-performing loans (NPLs), resulting in lack of trust for the banking industry.
A look into the structure of the financial system of the country
The financial system of Bangladesh is comprised of three broad fragments: formal sector, semi-formal sector and informal sector. The formal sector includes all regulated financial institutions. The semi-formal sector includes institutions which are regulated otherwise but do not fall under the jurisdiction of Central Bank. The informal sector includes private intermediaries which are completely unregulated. The following diagram delineates the broad structure of the country’s financial system:
The basic principle of how commercial banks make money is by providing loans and earning interest income from those loans. The loans that they are providing come from the deposits they are taking from people in return of interest and from their own reserves. Their share is the difference between the lending and deposit interest rate. The current weighted average deposit rate and lending rate of the country are 5.56% and 9.59% respectively. Commercial banks also earn revenue from commission based incomes from trade and treasury services.
The three main reasons for the current predicament of the banking sector are deposit shortage, declining asset quality due to governance issues and enormous competition within the industry. One of the most alarming symptoms to these causes is the rising level of non-performing loan. The amount of NPL stood at BDT 893.4 billion in 2018, which is more than 10% of the total loan disbursed. Along with these, some other factors also played a role behind the liquidity crunch. The next section puts a deeper look into it.
Lucrative and risk free saving certificate: In the past 5 years, the sales of National Saving Certificates have been soaring. The return rates of different saving certificates range from 11.8% to 12.2%, which is much higher than the bank deposit rates of around 6%.  Recently, to control government debt, the government has levied a 10% tax on the proceeds from NSCs, which previously was 5%. And they are stringently tracking the sale of NSCs with introduction of new rules. This has contributed to a fall in sales of NSCs from July 2019 onwards.
In the interbank market, the nominal exchange rate for taka-US dollar depreciated by 3.9% and the Real Effective Exchange Rate (REER) declined by 2.7%. Government injected USD 2.3 billion into the economy to adjust the exchange rate and to help banks make import payments. This has contributed to the outflow of funding from the banking system.
The uptrend in the percentage of NPL is an indication of the declining asset recovery rates of banks. This has caused an overall negative impact on the liquidity and the money supply of the economy. The prime reason for the rising NPL trend is poor governance at both private and government level.
Asset Structure: According to Bangladesh Bank’s guidelines on Risk Based Capital Adequacy (2014), banks must maintain a minimum total capital ratio of 10% plus a Capital Conservation Buffer of 2.5%. The rising NPL trend, poor corporate governance by banks and increased difficulties in recovering bad loans has led to the weakening of the asset quality of the banking sector. This is well depicted on the figure below where most state-owned commercial banks have failed to maintain minimum capital adequacy since 2013 and development finance institutions (DFIs) seem to be massively under-capitalized.
A fluctuating Advance Deposit Ratio (ADR) indicates inefficiency in liquidity management by banks. It also indicates fluctuating Statutory Liquidity Ratio. Moreover, we can see an uptrend in AD ratio since 2017 which can be credited to the new CRR policy by the central Bank.
For various reasons, the capital market hasn’t grown enough to counteract the liquidity crunch coming from the banking sector. Moreover, alternative forms of financing like private equity firms, venture capitalists, angel investors, crowdfunding etc. haven’t grown as much as they should have, which caused the financial system of the country to be heavily reliant on the banking industry.
From a remedial point of view, the first step would be to recognize each of these problems from both state and private level. The next step would be to bring a few changes in the overall functioning of the banking industry. Some other steps that might enhance the overall functioning of the banking system are:
The article is authored by Marzina Akhter Prottasha, Trainee Consultant at LightCastle Partners.
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