Bangladesh Bank (BB) reversed the requirement for conventional commercial banks to reduce Advances to Deposit Ratio (ADR) from 85 percent to 83.5 percent and Shariah based banks from 90 percent to 89 percent. Recall that BB lowered the maximum ADR in order to check excessive credit expansion and improve risk management on January 30, 2018, setting ultimately the deadline to meet this requirement at the end of September 2019 after several extensions.
The slowdown in private sector credit growth since then has been attributed in part to efforts on the part of banks reduce their excess ADR. Banks were reportedly poaching deposits and reducing advances. The critical question now is whether the reversal of the BB decision will boost private sector credit growth going forward. The aggregate ADR at the end of July 2019 was 91 percent, according to BB data. Therefore, at the aggregate level, the ADR still needs to contract even though, according to newspaper reports, several banks brought their ADR down to nearly 83 percent to comply with BB end-September deadline.
The excess reserves of banks have been declining of late. Bank deposit growth in July 2019 was 10.7 percent relative to July 2018 and advance growth was 11.6 percent. Currency outside banks grew 14.6 percent in July 2019 relative to July 2018. This reduces the capacity of banks to create credit. Government borrowing from the banking system increased by 33.7 percent in July 2019 relative to July 2018. The government's recent tightening of eligibility enforcement in purchasing National Saving Certificates may mitigate some of the liquidity pressure. However, relevant data is not available yet to figure whether the tightening is having any effect on NSC sales volume. Non-performing loans stood at 11.7 percent of total loans at end-June 2019, compared with 10.4 percent at end-June 2018. Last but not the least, bankers may already have relaxed efforts to tighten the ADR expecting either a further extension of the deadline or the reversal itself.
The conditions described above suggest it may be a little too optimistic to expect the reversal of ADR reduction to have any visible impact on private sector credit growth. What may help, however, is the reduced BB dollar sales in the foreign exchange market. BB sold $59 million in July-August and, so far, nothing in September. A $240 million external current surplus in July is likely to have reduced the excess demand pressure in the foreign exchange market.
What the banking system needs is game changing reforms. Walking the talk on changing laws to reduce both the stock and the flow of NPLs is long overdue. The Finance Minister on September 17 indicated the government's will "to bring required changes in the existing laws to rid the banks and financial institutions of the malaise". The changes are intended to ensure the adequacy of collaterals based on personal guarantee from directors and chairman of the borrowing entity against each of the loans.
The legal changes need to go well beyond requiring personal guarantees. BB currently has no legal basis for consolidated supervision of banking groups. There is no clarity on 'ultimate beneficial owner' in the law. The ultimate beneficial owner refers to any person with direct or indirect ownership or control of an entity. Identifying the ultimate beneficial owners is critical for ensuring compliance with the law in a banking sector dominated by founding family members who in many cases have a dominant role in the non-financial corporate sector.
At the of the day, durable results on more efficient financial intermediation cannot be achieved without improving the legal infrastructure, regulatory compliance and corporate governance. The indication of the government's will to address this starting with limited legal reforms is a refreshing change in the right direction. The next step is to walk the talk, sooner than later, and take on other key challenges in the reform agenda such as trimming excess capacity in the banking system, freezing regulatory forbearance regarding prudential standards and strengthening bank supervision.
The author is an economist.