The 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.
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.
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.