The Bangladesh Bank in a recent report has forecasted that default loans will increase further in the industry as an expected sluggish business condition due to the coronavirus outbreak could severely affect the debt-servicing capacity of the borrowers.
It also sees the risk of crowding out of credit for the private sector due to high bank borrowing and banks' preference to invest in risk-free government securities.
The central bank made the observations in the "Financial Stability Report-2019".
Though default loans of the banking sector declined substantially during the latter part of last year, thanks to massive loan restructuring, the proper monitoring of rescheduled loans amid the Covid-19 pandemic will be a critical challenge for the industry, the report said.
The central bank apprehended that most of the banking sector indicators might be affected by the Covid-19 pandemic.
However, the report said the bulk amount of the government's stimulus credit packages augmented by the central bank's refinancing schemes should help the banking sector in combating the Covid-19 pandemic.
The Bangladesh Bank's assumptions about rising default loans and crowding out private sector credit match with the bankers' opinion and are already reflected in the market indicators.
The default loan will see a jump after September when banks will start reporting classification of loans, said Md Arfan Ali, president and managing director of Bank Asia.
He said many customers will not be able to pay after lifting payment suspension due to not having adequate cash flow amid stagnation of business activities.
The Bangladesh Bank kept interest payment for borrowers suspended from January to September.
The private sector credit growth which came down to the level of 8 percent in March will fall further in the coming months due to the lending rate cap, said Selim RF Hussain, managing director of BRAC Bank.
The business of small and medium enterprises (SMEs) and retail segments could die out soon due to the interest rate cap as it is impossible for banks to run lending operations at the 9 percent rate, he said.
Selim said banks will remain shy in lending as credit risk is high during this pandemic situation.
The stability report shows that the banking sector rescheduled loans of a total of Tk52,770 crore last year, which was 127 percent higher from the previous year.
Due to a conducive policy support of the Bangladesh Bank, the rescheduled loans increased last year compared to the preceding year, the report said.
At the end of December 2019, the loans that had been rescheduled for at least once reached 14.1 percent of the banking sector's total outstanding loans and 79.6 percent of the rescheduled loans remained unclassified.
The default loan rate, which went up to a decade high of 12 percent in September last year, came down to 9.19 percent in December, which was the lowest in the last four years.
The default loan rate declined further to 9 percent in March due to suspension of loan payment for nine months during the pandemic situation.
Default loans showed a downward trend since last December due to a loan rescheduling spree under a special package at 2 percent down payment offered by the Bangladesh Bank in May last year.
The government's lenient rescheduling policy apparently paid off as default loans fell drastically by Tk22,000 crore in three months till December last year.
Soon after taking charge in January last year, Finance Minister AHM Mustafa Kamal had announced that default loans would not increase anymore.
Subsequently, the Bangladesh Bank relaxed its loan rescheduling policy that made it much easier for defaulters to turn their default loans into regular ones.
The central bank took the move with the expectation that it would bring down default loans significantly and that would pave the way for implementing a single-digit lending interest rate.
"The accumulation of huge rescheduled loans may create pressure on the profitability and solvency of the banks. So, intensive monitoring and execution of stringent measures for recovery of credit is needed to mitigate the downside risks of the banking system as a whole," the central bank opined.
Crowding out credit growth for private sector
The report said that credit growth in the private sector slowed down due to demand-side constraints from the higher rate on lending, lower import-based loan demand due to lower private sector investment, and the need to adjust the imbalance between deposit and loan growth last year.
Nevertheless, steps have been taken to rationalise the lending rate which might boost up loan growth in near future. Though loans and advances remained the dominant asset type, the banking industry increased its exposure to investment in the government and other securities, which registered an extensive growth of 28.1 percent last year from 2 percent in the previous year.
The government's higher reliance on bank-based budget financing, safety and security offered by the instruments along with rising yield in the government securities might have induced banks to invest heavily in these instruments. However, if these investments continue to soar in the future, there might be a possibility of crowding out of credit for the private sector.
Banks should aim to increase their deposit base so that such a situation does not materialise, the report suggested.