Mirza Azizul Islam

The Way Forward For the Banking System of Bangladesh

December 17, 2009

The Context
mirza_azizul_i-1The management of the banking system has emerged as a top priority issue on the policy agenda of many countries in the wake of the global financial crisis that rapidly engulfed many countries. The crisis originated in the housing and credit bubble in the United States. During several years preceding the first signs of crisis in August 2007, the United States saw the emergence of what Paul Volcker, the former Chairman of the Federal Reserve System called “bright new financial system”. Under this so-called new system, the banks securitized their future receipts against loans to investors and consumers. These securitized assets were then pooled, divided into risk tranches and sold to other institutions. The process was repeated several times giving rise to a complicated set of debt products which came to be known as collateralized debt obligations (CDOs) and credit default swaps (CSOs). The phenomenal growth of debt products was fuelled by bubble in asset prices under loose monetary policy regimes which provided wide access to borrowing at low interest rates. This enabled consumers to live beyond their means and investors to buy assets with borrowed funds. Banks avoided capital and other regulatory requirements by treating securitized assets as off-balance sheet items.

Eventually many borrowers failed to meet their obligations, leading to fall in asset values (both houses and other securitized financial assets) and credit squeeze. The credit squeeze translated into reduced demand for consumption and lower investment with devastating impact on the real economy. The United States, most European countries as well some heavily export dependent Asian economies will have negative growth in 2009. Practically all countries of the world will suffer deceleration in growth rates, even if positive.

Bangladesh Scenario
The banking system of Bangladesh is not significantly integrated with the international financial markets. This lack of integration has ensured that our banking system is not exposed to toxic assets and therefore remains immune to the global financial crisis per se. Nevertheless, the impact on the real economy poses some threats. These threats emanate from the following sources:

(i) At the macro level, growth rate in 2009-10 is likely to be slower than in the preceding fiscal year.

(ii) Export growth in the first quarter of the current fiscal year turned substantially negative.

(iii) Even the exports of ready made garments sector which showed tremendous resilience against global recession experienced negative growth of about 5 per cent in the first quarter of the current fiscal year. This sector accounts for over three-fourths of our total exports and a large part of our industrial output.

(iv) Parallely, the growth of imports has also turned negative encompassing all categories – raw materials, intermediate goods, capital goods as well as consumption goods.

(v) The remittances have so far held up strongly. However, unfavourable developments in the major destinations of our migrant labour e.g. Dubai, Saudi Arabia and Malaysia cast doubt over medium – term sustainability.

The implications for the banking system
The above scenario is likely to have considerable negative implications for the income of the banking sector because of the following reasons.

(i) The slow-down of growth of GDP and industrial production and negative growth of exports and imports would imply reduced demand for credit. Our banks are largely dependent on interest income. The reduced demand for credit is likely to have an adverse impact on interest income. That there has been a significant decline in demand for credit is evidenced by the huge accumulation of excess liquidity which, according to the latest available data, amounted to Tk. 40,000 crores.

(ii) The shrinkage in foreign trade and potentially remittances is likely to reduce fee-based income of the banks.

(iii) The slow-down of industrial production would cause a reduction in demand for term loan adversely affecting traditional asset base.

(iv) It is understood that because of slow implementation of both revenue and development budget, the Government also did not borrow from the banking system in the first quarter of the, current fiscal year. This implies that bank’s income from lending to the Government has also become constrained. In fact, the Government reportedly repaid previous loans.

Mitigating actions
In order to minimize the potentially negative impact, the banking system has to adopt a number of measures. These are briefly noted below:

(i) The banks should make determined efforts to increase income. They can do so by diversifying their asset base. In this context, they should consider expansion of loan to the un-banked or under banked sectors such as agriculture, small and medium industries and small scale domestic traders.

(ii) With a view to diversifying asset base as suggested above, the banks must depart from the traditional practice of collateral-based lending. They should aggressively seek out new borrowers with high income potentials and viable project proposals.

(iii) Banks should also consider offering new products such as swaps, options and derivative products. However, they must make sure that they do not assume unsustainable risk from such operations. The Central Bank needs to issue guidelines in this regard.
(iv) All out efforts should be made to recover non-performing loans (NPL). It is understood that the state-owned banks have been able to reduce their NPL to total loan ratio, but mostly by rescheduling rather than cash recovery. On the other hand, NPL ratios of the privately owned banks have recently gone up.

(v) In order to increase profitability, the banks need to focus on the volume of business and total profit, not per unit profit. This implies that they should reduce the prevailing high spread between deposit and lending rate, particularly by reducing the lending rate. Some progress has been achieved in this respect, but not enough. Moreover, the banks have considerably reduced deposit rates. This poses the risk that depositors will shift into non-bank assets such as stocks, real estate etc. The price increases of these assets suggest some movement in this direction.

(vi) The banks should also look at their expenditure side to improve income-expenditure ratios. In particular, salaries and perks of employees and directors and ostentatious expenses on branch decorations should be reduced.

(vii) Finally, banks should strengthen their risk management and early warning systems so that they are not caught off-guard by developments in the real economy.

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11 Responses to “ The Way Forward For the Banking System of Bangladesh ”

  1. Matiur Rahman on January 15, 2011 at 1:11 am

    Dr. Islam has mentioned some factors that led to current US recession and gradually transmitted to the rest of the world depending on the extent of integration with the U.S. economy.Particularly, Euro economies have been hit the hardest.For deatailed analyses of this issue of vital interest today, please visit http://www.ijeronline.com for my article on” Genesis of Current U.S. great Recession and Its Global Transmission”, published in Vol.1, Issue 1, Nov-Dec 2010.
    Some of the apprehensions expressed by Dr.Islam about declining exports, imports and remittances turned out to be wrong for 2010 to have discernible detrimental effects on Banladesh banking sector. They all went up, although outmigration declined. Remittances are not always procyclical. It also has some countercyclical component.
    About mitigating factors that he mentioned, some of them were practiced in USA and Western Europe through 1990s until the end of 2007. The subprime loans, credit card proliferations, and proliferation of complex financial dervatives, led to the current crisis, in part. I think,Dr. Islam drew ideas from the above as solutions for Bangladesh banking problems. In so doing, he seems to be wrong.
    At the very end, he mentioned about risk management and early warning system. He should have elaborated on them. Risk management in banking sector is a vast topic. What kind of risk he had in mind should have been mentioned in specific terms. For early warning, what kind of rating system he had in mind should have been stated as well.Is it CAMEL rating?
    In fact, he should have suggested mitigating factors drawing lessons from India, China, Malaysia, the Phillippines, New Zealand, etc, and even the failing state of Pakistan.Anyway, I enjoyed reading his article.

  2. Ershad Mazumder on December 6, 2010 at 8:37 pm

    Thanks a lot for your nice opinion on Bangladesh’s banking system. It is a question of practice and theory. Our economists are theoretical. Please remember the great failure of our first planning commission represented by Prof Nurul Islam and Rehman Sobhan. Bangabandhu trusted them to reach his politico-economic destination.

  3. Jose Joice on July 8, 2010 at 5:41 pm

    I was studying something else about this on another blog. Interesting. Your perspective on it is novel. “If I were in this business only for the business, I wouldn’t be in this business”. – Samuel Goldwyn 1882 – 1974

  4. The Peoples on May 20, 2010 at 5:05 pm

    Experienced Peoples are of the opinion that Bangladesh wont be able to enjoy the advancement of Science and Technology like other Asian countries. Bangladesh is unlikely to enjoy the digital era with the existing colonial laws and legal system.

  5. Loyd Whiteford on March 5, 2010 at 2:54 pm

    Super stuff! I truly enjoyed this contribution – very clear and to the point. Exactly what I like.

  6. Hyman Dahlhauser on February 20, 2010 at 5:57 am

    Thanks for the marvelous post! I found your post very interesting, you are a marvelous author. I just bookmarked your blog and will come back soon to your blog. Keep up the brilliant job, have a nice day!

  7. Nazmul Ahsan on January 23, 2010 at 8:51 pm

    It’s a wonderful article. Please keep on writing on macro-fundamentals of both local and regional economies.

  8. Mustaq Khan (Economist & Commercial banker) on January 5, 2010 at 12:27 pm

    We are pleased to see an interesting article on banking in Bangladesh. I personally wish to thank Mr. Islam for taking the initiative.
    I wish people to read the “Mitigating actions” as suggested by him. I wish to humbly record few observations and encourage the visionary to join with contributions.
    The mitigating actions suggested are in line with the needs and priorities of the economies which are grossly different from Bangladesh.
    I wish to encourage plans and visions for Bangladesh banking system to benefit i.e. the mass millions of the country and not for the 2% elite as is now. Which I see as very selfish and short-sighted.
    We need to have a long-term plan and banking system which shall deliver the platform for the masses to benefit and allow a sizeable growth for their well-being & towards sustainable economic growth. Taiwan & China could shed light as examples as to the strategy they adopted about 10 years ago.
    We have our own successful example, thanks to Dr Yunus and the world recognised its potential.
    Appropriate & visionary banking system suitable for the long term needs of the country and also negating the short term profitability & greed factor is an urgent need for Bangladesh.

    Let us all then try and structure a banking system:
    a. For the 150 million Bangladeshis to take advantage
    b. The banking system to have a long term vision.
    c. The people to take benefit of the system to promote sustained & balanced economic growth.
    d. Potential growth areas & sectors of the country be bonded & partnered to the future banking system.

    The question we need to ask is whether we are committed to bring the resources we are endowed with — intellectual, population, natural resources and excess liquidity — in order to ensure a prospective future for Bangladesh.

    Mustaq Khan
    Associate Fellow of Australian Institute of Management

  9. Saleh-Rahim Ahmed on December 18, 2009 at 1:18 am

    Dear Dr. Mirza Azizul Islam – when you were Adviser in CTG in that couple of years – you mentioned in several occasions Bangladesh will not be effected by global economic meltdown – once your views referred to a British Dr. Economist Parliamentarian – his reaction was “Does Bangladesh have any Economy?” Neither of you were prescribing proper precautionary-dose of medicine according to the size of Patient’s body! You were denying the inevitable up-coming virus – Briton was poking the joke on patient’s physical existence – both were considered to be extremism to some extent!

    Finally you are telling us that Bangladesh is also affected – definitely depending on its physical nature & size! As per as we can imagine Bangladesh economy and banking systems’ natural similarity with any developed country like USA may be still in single digit percentage! You have rightly pointed out that even in USA “loose monetary policy to blame for bubble in assets’ price, access to borrowing at low rate interest letting the borrowers living beyond their means”! Same thing happening in Bangladesh – as you mentioned in Real Estate Price! For example a buyer paying BDT 3,00,00,000 (three Crore) for a flat or plot through Banking channel and/or cash money receipts – getting the document registered for same property mentioning just 50,00,000 (fifty lahks) or less to avoid the Government registration fee – ironically there no body to ask where these money coming from – and how it was accounted for!

    As the Finance adviser of CTG and the Chairman of SEC you have had the opportunity to see & deal with the whole financial system and capital market mechanism in practice in our country thus enabling you to know the real problems exists! Almost every sensible citizen without being financial expert knows – our banking system is crippled due to ‘outstanding debts’ – contribution of the lending practice without proper scrutiny of borrowing capacity and follow-up thereon, under the exercise of political power and/or ill funded financial muscles! Even you have talked on the issue some times – probably you could not take proper action to minimise the financial erosion! Could we still continue to afford that unethical luxury? If not??

    Dr. Islam, being a distinguished citizen of the democratic Bangladesh – probably you have now better chance than in those above-mentioned position to let the nation know the major problems in our ‘public financial system’ and the solution to overcome – including the financial accountability in all level of Governance, that would be highly appreciated by the nation!
    Good Luck! Regards
    Saleh-Rahim Ahmed

  10. Saif Tinku on December 18, 2009 at 1:17 am

    Thank you Mr Mirza Azizul Islam for your very timely article as Bangladesh economy is already warned for lower growth for the fiscal year 2009-10. However, why you only emphasized on profitable lending of banks without mentioning productive lending?

    • M.A. Rahat on December 30, 2009 at 1:13 am

      Mr. Saif Tinku has pointed towards a very important subject. Why you are giving priority on banks’ profitability skipping manufacturing? Banks have started businesses by investing Tk 10 crore maximum, as paid up capital, and now most banks are profiting far more than eight times that amount. Is that not enough??
      Banks are acting as brokerage house for the share market. This should not be the role of banks. Banks are taking money from the future income of the general public by offering credit cards, car loans, house loans, etc.
      Banks are negative in employment generation investment. This type of vision will create depression in our economy soon.

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