Non performing loans threaten banking sector

In June 2017 the government allocated Tk20bn (US$250m) to recapitalise Bangladesh’s state-owned banks. There are signs that the country’s banking sector is facing mounting problems, and regulators’ efforts have so far been insufficient to tackle the issue. In a recent report, the IMF said that there were weaknesses in the banking sector of Bangladesh owing largely to the legacy of loans to large borrowers, who lack incentives to repay, and legal limitations that hamper recoveries.
The eight state-owned commercial and specialised banks suffer from problems related to high levels of non-performing loans (NPLs), low profitability, large capital shortfalls and balance sheet weaknesses. For decades, state-owned banks have lent large amounts to big, influential borrowers, who have been known to be lax with repayments. Defaulters are rarely penalised; instead, loans are routinely restructured to permit further lending to the same borrowers. According to a study by the Bangladesh Institute of Bank Management, on average banks rescheduled bad loans of Tk109.1bn annually during 2010-14.
As a result of these issues, non-performing loans (NPLs) at state-owned banks have risen sharply in recent years. In January-March 2017, overall, bad loans in the banking sector rose by 18% from the previous quarter, to Tk734.1bn. NPLs at the six state-owned commercial banks rose by 15.1% quarter on quarter, to Tk357.2bn, accounting for just under half of total NPLs.
Unsurprisingly, these high NPLs have hit profitability hard. In 2016 the operating profits of the six state-owned commercial banks dropped by 37% annually, to Tk20.1bn, while net losses surged by 309%, to Tk5.1bn. Meanwhile, losses at the two state-owned specialised banks (Krishi Bank and Rajshahi Krishi Unnayan Bank) rose by 150%, to Tk4.2bn. By contrast, the net profits of the banking sector as a whole rose by 4.9% in 2016, while those of private banks rose by 17.2%.
The higher provisioning necessary against these NPLs has also weakened banks’ capital. By the end of the first quarter of 2017, seven of the eight state-owned banks had capital shortfalls, totalling Tk147bn, compared with only two private banks with shortfalls.
The decision to provide funding to the failing banks has been criticised, as it has been seen by some as the government diverting taxpayers’ money away from needed investments in social sectors like healthcare without putting the necessary measures in place for structural reforms. In a March 2017 meeting the government’s finance division observed that, despite the regular infusion of budget funds, state-run banks have not improved their NPL positions. Meanwhile, reportedly, in the past two years BB did not recommend any capital infusion for these banks to the finance ministry. In mid-2017 BB asked the state-owned banks to meet shortfalls at their own initiative, such as by boosting business activities.
Despite this, in the budget for 2017/18 the government has again earmarked Tk20bn to recapitalise state-owned banks, against the March 2017 capital shortfall of Tk147bn, with the highest amount going to BASIC Bank (Tk10bn). In February 2017 the central bank governor termed the bad loan problem at state lenders “alarming” and attributed it to banks favouring a few large companies, pointing out that 40% of Janata Bank’s loans, for instance, have gone to just nine big industrial groups.
Nevertheless, the regulatory response to the banking sector’s problems needs improving, with little action taken so far to penalise defaulters, improve risk management and strengthen bank management. Apart from the political influence of large borrowers, regulators are concerned that too hard measures could force corporate bankruptcies, raising unemployment. Since the six state-owned commercial banks employ almost 60,000 people and have 55% of branches in rural areas, regulators are also cautious about measures that might destabilise these.
Regulatory measures to resolve NPLs have not been as successful as officials had hoped. For instance, in 2015, after pressure from large borrowers, BB issued a more lenient rescheduling policy for borrowers with loans exceeding Tk5bn. Thereafter, 20 companies applied for the facility, and 11 industrial groups were allowed to reschedule loans worth about Tk150bn. Repayment of the rescheduled loans was to begin in December 2016, but many of the companies have made only partial or no repayments and are now asking for further loans or rescheduling.
Regulators will need to make further efforts to tackle the sector’s deep-rooted problems of corruption, poor risk practices and collusion with industry. As the IMF pointed out in its report, an implicit government guarantee on their deposits keeps state-owned banks highly liquid, but a further deterioration in their balance sheets could negatively impact the fiscal balance. It suggests that banks should be held strictly accountable to numerical targets agreed upon with the authorities and that reforms should focus on improving supervision, containing risks from loan concentration and improving the legal and financial framework for loan recovery. However, ultimately, any real clean-up of Bangladesh’s state-owned banks will have to begin with political will, which appears to have been limited so far.