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Bangladesh: Selected Issues and Statistical Appendix

Author(s):
International Monetary Fund
Published Date:
June 2002
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III. THE Banking Sector in Bangladesh1

A. Introduction

1. Despite significant financial sector liberalization during the 1990s, the banking sector in Bangladesh remains mired in difficulties. While the performance of private banks (PCBs) appears to have improved in recent years—prompted by successive waves of privatization of smaller state banks and the entry of several new banks—the problems in the four dominant nationalized commercial banks (NCBs) and in the development finance institutions (DFIs) remain acute. This chapter outlines the structure and recent performance of the commercial banking sector and the DFIs (Sections B and C), as well as recent reform efforts and outstanding issues (Section D).

B. Overview of the Banking Sector

2. As of December 2001, the financial sector of Bangladesh consisted of the banking system, which includes the Bangladesh Bank (BB) and 51 licensed commercial banks, 3 cooperative institutions, 23 leasing and finance companies, and the stock and bond markets.2 Of the 51 banks, there are 30 local PCBs, 12 foreign commercial banks (FCBs) which are mainly involved in international transactions, 4 NCBs, and 5 government-owned DFIs. The latter consist of agricultural and industrial development agencies, with assets comprised largely of loans to the target sectors and government security holdings, and liabilities comprised of deposits and refinance credit from BB.

3. Despite some decline in recent years, the banking system continues to be dominated by the NCBs. At end-2001, the state-owned banks accounted for almost 59 percent of overall banking sector deposits, PCBs 34 percent, and FCBs 7 percent; the dominance of the state-owned banks is even higher in terms of risk-weighted assets (Figure III.1).

Figure III.1.Bangladesh: Risk-Weighted Assets and Deposits of Banks

Source: Bangladesh Bank.

C. Performance of the Banking Sector

4. For the past few years, BB has used the U.S.-style CAMEL rating system to evaluate the Bangladesh banking system. As of June 2000, 8 banks were rated as strong (1), 15 as satisfactory (2), 13 as fair (3), and 13 as marginal (4). All four NCBs and four of the five DFIs had a marginal rating.3 A year later, however, the ratings improved somewhat: 7 banks were rated as strong, 20 as satisfactory, 6 as fair, and 15 as marginal, including again all the NCBs and 4 of the 5 DFIs. The following discussion uses the CAMEL elements to analyze the recent improvement in performance.

Capital adequacy

5. Since 1996, banks in Bangladesh have been required to adopt the Basle minimum capital standard equal to 8 percent of risk-weighted assets, with core capital equal to at least 4 percent of risk-weighted assets. The banking sector’s average actual capital adequacy ratio has actually declined from 7.4 percent in December 1999 to 6.7 percent in December 2001; declines were registered for all types of banks except the FCBs. At end-2001, capital ratios ranged from 16.8 percent for FCBs to only 3.9 percent for DFIs.

Asset quality

6. The loan classification and loss provisioning criteria, and their enforcement, continue to be less stringent in Bangladesh than international standards.4 Even so, nonperforming loans (NPLs) (as proxied by classified loans) to total loans are large, which rose from 32 percent in 1995 to 43 percent in June 1999 before falling to 31 percent by end-2001. Throughout this period, both the NCBs and DFIs recorded the highest ratio of classified loans, although they have been reduced somewhat from the peak in 1999 (Annex Table III.1.1).5 The recent improvement in the classified loans ratio can be attributed to the strengthening of supervision and the enforcement of regulations in 2000–01. For example, BB is now conducting both on-site and off-site supervision of banks, and inspections have been intensified based on bank performance.

7. Nonetheless, even after these recent improvements, commercial banks faced an over-all provisioning shortfall of 44 percent, with NCBs accounting for the bulk of the shortfall. At end-2001, actual provisioning stood at 35 percent for NCBs, 77 percent for PCBs, 100 percent for DFIs, and 124 percent for FCBs. The high level of actual provisioning by DFIs is a new requirement by the government in light of their poor quality of lending in the past.

Management quality and conduct

8. A significant proportion of the bank system (NCBs and DFIs) is owned by the state (i.e., Ministry of Finance) and large sponsors or shareholders. Listed PCBs are primarily owned by sponsors (48 percent) and the general public (26 percent); the share of foreign ownership in the banking system is quite low, at less than 1 percent. Under the Bangladesh Bank Order (1972), the Ministry of Finance has the ultimate jurisdiction over the NCBs and DFIs (including supervision). The periodic appointments of military officers and political figures as heads of several NCBs have politicized credit decisions and weakened the asset quality of these agencies. Politicians and government officials could interfere the operations of the NCBs and DFIs, while their management is not generally held accountable for performance. Further, insider lending is legally sanctioned in Bangladesh. BB has recently set limit on banks loans to their own directors equivalent to 50 percent of the paid-in capital, and a limit on the directors’ shareholdings in any bank equivalent to no more than 10 percent of its capital. However, enforcement of these actions remains inadequate.

Earnings performance

9. Financial indicators of the banking system during 1996/97–2000/01 (Annex Table III.1.2) showed that FCBs enjoyed the highest level of net profit per loan (5.8 percent for 2000/01), followed by PCBs (2.3 percent), whereas DFIs faced negative net profit rates for the entire period. NCBs net profits were marginally positive, and indicated some increase in 2000/01. The ranking of net profit per loan is closely related to income per loan, and FCB have the lowest expenditure per loan. Both measures of loan productivity (lending per branch and per employee) ranked FCBs as the highest, followed by PCBs, DFIs, and NCBs. Over the years, both these measures have remained virtually stable for DFIs, while lending per branch increased for NCBs with little change in lending per employee.

Liquidity

10. Presently, the commercial bank’ deposits are subject to a statutory liquidity requirement (SLR) of 20 percent, of which 4 percent as cash reserve requirement (CRR) with the central bank and the remainder as qualifying “secure” assets under the SLRs, either in cash or government securities. Until February 2002, banks were allowed to count their foreign exchange deposits with BB as cash reserves, which weakened BB’s monetary control significantly. The large amount of treasury bill holdings by banks in order to satisfy the SLR have crowded out credit to the private sector and increased the spread between banks’ lending and deposit rates.6

11. Liquidity indicators measured by liquid assets/deposits and excess (shortfall) liquid assets/deposits indicated that all banks had excess liquidity during the period 1995–2001. FCBs have the highest liquidity ratios and DFIs the lowest. In terms of excess liquidity ratios, NCBs and PCBs have the lowest. The level of excess liquidity in DFIs has shown some increase mainly because of recent limitations imposed on new lending.

D. Outstanding Reform Priorities

12. In response to the high level of classified loans and other weaknesses identified above, the authorities have introduced several reforms in recent years. While these efforts have been a promising start, and indeed have started to show some results, they proved to be insufficient to address problems related to ownership structure, poor asset quality, governance, and inefficiency. A more comprehensive reform program is needed. The forthcoming Financial Sector Assessment Program (FSAP) to be jointly conducted by the IMF and the World Bank will help the authorities to develop such a program to reform the banking sector.

13. Strengthening prudential control and supervision will be an essential component of the reform strategy. Recent efforts have focused on enhancing asset quality, improving loan classification, placing BB officials on the Boards of banks, and better monitoring and enforcement of the net open foreign exchange positions. However, the banking law does not include procedures for the winding-up of problem banks, and the BB lacks the legal right to enforce corrective measures over the NCBs and DFIs. Both of these issues need to be addressed expeditiously. In particular, bringing the supervision of banks under BB will be important in this regard.

14 Effective corporate insolvency and associated debt-recovery procedures form an important pillar of banking sector efficiency. These procedures include formal laws and informal rules for enforcement of debt contracts, bankruptcy liquidation, and the rehabilitation of distressed firms. In Bangladesh, the corporate insolvency procedures continue to favor the government, employees, insiders, and debtors. Indeed, relative to other Asian economies, the process of insolvency and debt-recovery procedures in Bangladesh is amongst the slowest and most expensive.7 Specifically, the debt-recovery process is highly debtor-friendly and the time spent for winding up a corporation, both formally and informally—about 7–8 months—is the longest among the sample economies studied. The judicial process with regard to debt recovery is also the slowest among the sample economies, with defendants typically using loopholes in the bankruptcy laws to delay judgments (Box III.1 and Annex Table III.1.3). Further efforts in this area are required if debt resolution is to be expedited.

Box III.1.Bangladesh: Evolution of Laws to Enhance Recovery of Delinquent Loans

There are several legal measures available to banks for loan recovery:

Filing money suit/title suit under Artha Rin Adalat (Court) Act, 1990: Prior to this Act, there were no special laws for recovery of defaulted loans, making it difficult to take legal action against the delinquent borrowers and thereby to safeguard the interest of banks. Following recommendations of the 1990 Financial Sector Reforms Program (FSRP), a legal framework for loan loss recovery far all financial institutions was established. Various amendments have been made during 1990–97 in order to improve enforcement of this Act.

Filing bankruptcy cases under Bankruptcy Act, 1997: The Bankruptcy Act was intended to expedite bankruptcy declarations. The order of payment priority at bankruptcy established under the Act is: a) all taxes and other debts of a like nature due to the government; b) all wages or salaries, not exceeding Tk 2000 due to any clerk, servant, laborer, or workman in respect of services rendered to the debtor during the period of six months immediately before the filing date; c) all bank debt; d) all unsecured claim; and e) any subordinate claim. Nonetheless, to date enforcement of the Act has remained difficult. As of end-2000, the number of suits settled amounted to only 16 percent of total suits filed in the bankruptcy courts, while actual recovery was only 8 percent of the amount claimed at settlement, and 0 percent of the amount claimed at the filing date (see Annex Table III.1.4).

Other legal actions: These include: (i) filing criminal cases for breach of trust, including unauthorized sale of mortgaged property or assets created out of bank loan, migration to other places without repaying bank dues, fake loans, and so forth; (ii) riling a summary procedure suit under the Civil Procedure Code whereby the defendant is given a limited time, say one month, to explain the reasons why he/she should be allowed to defend the case; and (iii) recovery of loans through the sale of mortgaged property or taking over management of the defaulting concern (restricted to some banks and DFIs). However, for all these actions, since most collateral consists of immovable property and land registration procedures inadequately define property rights, it is generally difficult for creditors to rely on collateral and conduct the loan recovery process.

Sources: Moral, M.L.H., A. J. Chaudhury, and M. M. Siddique, 2000, “Enforcement Status of Laws Relating to Defaulted Bank Loans,” discussions Bangladesh Institute of Bank Management, Dhaka (October); and Fund staff with authorities.

15. Ownership rules and procedures have been at the core of the weaknesses of the banking sector, enabling government interference in implicit directed credits to preferred sectors and activities, as well as extensive (legally sanctioned) insider lending. In this context, privatization of banks must be reactivated, which should be accompanied by structural reforms of the banking sector, including strengthening prudential regulations and supervision, effective resolution of NPLs, and improving capital adequacy. The improved performance of several local banks that have already been privatized suggests potential benefits from this approach. The improved efficiency would also help in lowering the borrowing-lending rate spreads and ensuring that interest rates respond more quickly to changes to monetary conditions.

16. Finally, continued macroeconomic stability and development of the financial system with better primary and secondary treasury bill markets, lowering artificially high interest rates in national savings certificates, which compete for bank deposits, and the removal of all administered interest rates, will assist in enhancing the stability and efficiency of the banking sector in Bangladesh.

ANNEX III.1
Table III.1.1.Trends in Classified Loans to Total Loans as End-December(In percent; includes interest suspense)
YearNCBsPCBsFCBsDFIsAll Banks
199531.039.45.432.0
199632.634.84.731.5
199736.631.43.665.737.5
199840.432.74.166.740.7
199945.627.13.865.041.1
200038.622.03.462.634.9
200137.017.03.361.831.5
Source: Banking Regulation and Policy Department, Bangladesh Bank, 2001.
Source: Banking Regulation and Policy Department, Bangladesh Bank, 2001.
Table III.1.2.Bangladesh: Financial Efficiency Parameters by Bank Type, 1996/97–2000/01
Efficiency ParameterBank Type1996/971997/981998/991999/20002000/01
(In percent)
Income per loan outstanding 1/All banks 2/13.314.115.715.0
NCBs14.613.815.817.418.5
DFIs5.718.014.912.6
FCBs15.816.119.417.119.0
PCBs14.413.014.812.315.1
Expenditure per loan outstandingAll banks 2/12.513.414.914.4
NCBs13.013.615.717.317.1
DFIs12.827.023.720.5
FCBs7.18.811.59.68.8
PCBs12.710.812.110.512.0
Net profit per loan outstandingAll banks 2/0.30.20.30.0
NCBs1.50.20.10.01.0
DFIs−7.1−9.2−9.1−8.1
FCBs4.33.94.64.45.8
PCBs1.11.62.11.22.3
(In millions of taka)
Loan outstanding per branchAll banks 2/48.048.952.661.6
NCBs40.542.543.844.655.9
DFIs35.819.525.131.7
FCBs921.71,012.01,039.31,179.31,024.9
PCBs67.980.085.3117.2149.9
Loan outstanding per employeeAll banks 2/2.82.83.13.5
NCBs2.32.42.52.53.2
DFIs2.51.41.82.3
FCBs21.924.925.927.128.9
PCBs3.64.14.46.07.4
Sources: Bangladesh Bank, Economic Trends. 2001; and Fund staff estimates.

Total loans outstanding for all categories of banks are adjusted for classified loans.

Excluding the central bank. For NCBs, PCBs, and FCBs figures are based on calendar year, while DFIs are based on fiscal year.

Sources: Bangladesh Bank, Economic Trends. 2001; and Fund staff estimates.

Total loans outstanding for all categories of banks are adjusted for classified loans.

Excluding the central bank. For NCBs, PCBs, and FCBs figures are based on calendar year, while DFIs are based on fiscal year.

Table III.1.3.Summary Evaluation of Processes for Debt Recovery
BangladeshIndonesiaKoreaMalaysiaPhilippinesTaiwan Province of ChinaThailand
1 = low cost(or not expensive), easy, very efficient, quick;

3 = very expensive, very difficult, inefficient and very slow
1. Process for acquiring security (collateral) over land3.002.751.251.251.51.51.5
2. Process for acquiring security over other property2.552.751.251.251.51.51.5
3. Process for enforcement of security over land3.0031.251.2521.751.25
4. Process for enforcement of security over other property2.502.51.251.2521.51.75
5. Process for debt collection2.752.51.251.25321.5
6. Process for winding up insolvent corporation3.002.51.252321.5
7. Process for reorganization/restructuring3.002.51.7522.252.251.5
8. Time for winding up7-8 months4-6 months6-12 months6-12 months≥6 months≥6 months≥6 months
9. Time for formal reorganization7-8 months12-18 months2-4 months8-12 months18 months8-12 months18 months (since 98)
10. Time for informal workout7-8 months4-8 months2-4 months2-4 months12-18 months12-18 months18 months
11. Incidence of bankruptcy/liquidationvery lowvery lowlowhighN/Avery lowlow
12. Incidence of reorganization/restructuringN/AN/AhighhighN/Avery lowvery low (since 98)
Workouts preferred because:
13. Bankruptcy procedures are a real alternativeNoAdverse effectgovernment encourages workoutyesnonoyes
14. Better outcome than under formal proceduresNonono, for secured creditorsyesnoyesNo
Predictability of positive outcome of:
15. Process for security enforcement; land5.00522222
16. Process for security enforcement; other than land4.50542213
17. Judicial handling of security enforcement5.00532322
18. Judicial handling of debt collection5.00532312
19. Judicial handling of bankruptcy/liquidation5.00542454
20. Judicial handling of rehabilitation5.00543455
Sources: Asian Development Bank, Local Study of Insolvency Law Regimes (1998) for Asian economies prior to the crisis; and banking expert in Bangladesh (2001).
Sources: Asian Development Bank, Local Study of Insolvency Law Regimes (1998) for Asian economies prior to the crisis; and banking expert in Bangladesh (2001).
Table III.1.4.Statement of Suits Filed and Settled in Insolvency Court for Period Ending December 2000(In millions of taka for amount claimed and recovery)
Type of BankSuits Filed (Cumulative)Suits Settled (cumulative)Suits Under Trial
Number of SuitsAmountClaimeNumber of SuitsAmount ClaimedActual RecoveryNumber of SuitsAmount ClaimedRecovery Against Claim
NCBs (4)956,446101305956,31612
PCBs (17)933,5112219S43713,3145
DFIs (5)386,08352731335,8100.3
FCBs (13)1700170
Total22716,04137600501915,44017
Source: Bangladesh Bank.
Source: Bangladesh Bank.
1

The main contributor to this chapter was Mr. Qaizar Hussain (ext. 37334).

2

Nonbank financial markets are relatively underdeveloped and do not constitute important sources of financing for investment and savings. The total market capitalization of all listed securities as of December 2001 amounted to $1.1 billion (3 percent of GDP) with 250 listed securities. Nationalized savings certificates issued by the Treasury pay a premium interest rate and represent the main competition for funds for the banking system; their stock was around 9 percent of GDP at end-2001. The insurance industry is at an infant stage, although the number of leasing and finance companies has picked up sharply in the recent past.

3

As part of the CAMEL rating system, banks are scored every six months on a scale of 1 (best) to 5 (worst) using five criteria: capital adequacy, asset quality, management quality, earnings performance, and liquidity. A composite score is then produced. Banks with scores of 1 or 2 are considered satisfactory, but a score of 5 indicates that examiners feel the bank is likely to fail.

4

Since 1997, loans are classified as “substandard” when overdue for 9–24 months (international standard: 4–6 months), “doubtful” for 24–36 months (international standard: 7–12 months), and “bad” for 36 months or more (international standard: 13 months or more). The provision requirements are for: unclassified loans: 1 percent; substandard: 10 percent (with 20 percent the international standard); doubtful: 50 percent; and bad loans: 100 percent.

5

After excluding interest suspense, the ratio of classified loans to total loans for all banks (as of December 2001) dropped from 31 percent to 24 percent.

6

The weighted average rates on lending and deposits were 13.1 percent and 9.5 percent as of October 2001. Both the PCBs and the FCBs had lending margins around 1 percentage point higher than the DFIs and the NCBs.

7

See Hussain, Q., and C. Wihlborg, 1999, “Corporate Insolvency Procedures and Bank Behavior: A Study of Selected Asian Economies,” IMF Working Paper No. WP/99/135.

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