Rapidly implementing bank mergers may undermine confidence in banking sector: World Bank

Forced bank mergers may be counterproductive without a thorough assessment of asset quality, said the World Bank in its latest report on Bangladesh.

"Rapidly implementing bank mergers before addressing these issues may further undermine confidence in the sector, deterring intermediation capacity," according to a report titled "Bangladesh Development Update, Special Focus: Strengthening Domestic Resource Mobilization", released by the World Bank on Tuesday (2 April).

"A consolidation process will require careful assessment and prudent implementation of procedures to avoid weakening good banks acquiring bad banks. An assessment of the asset quality of weak banks will be required," said the report.

In March 2024, following the Bangladesh Bank's plans to merge weak banks with strong banks, EXIM Bank and Padma Bank signed a letter of intent to merge, initiating the first merger process.

The report suggested that "prior to initiating any merger processes, detailed guidelines on mergers and acquisition need to be issued, allowing banks a clear idea about the process involved. Such guidelines can be based on international best practices and provide alternative merger mechanisms for banks to choose from depending on the status of the banks/non-bank financial institutions deciding to merge".

"Bank mergers will also require an evaluation of internal systems, branch networks, staffing levels, adequacy of management arrangements, impacts on banks' cross-border business and international risk ratings," as per the report.

"Given the high prevalence of NPLs and undercapitalised banks, additional tools will likely be required to address vulnerabilities, including strengthening corporate governance, and introducing stronger financial safety nets such as modern least cost resolution tools for insolvent banks, and stronger deposit insurance," the report reads.

'Crawling peg exchange rate needed to rebuild reserve'

The World Bank report also said that the crawling peg would need to be a market-clearing exchange rate mechanism that reduces the gap between the formal and informal exchange rates.

"This would help rebuild external buffers by attracting remittances through formal channels, making informal channels less attractive, and reducing the financial account deficit by expanding trade credit and other forms of external financing," said the report.

At present, the official exchange rate is Tk110 per dollar, while the unofficial rate is above Tk115-Tk120.

From January to June 2024, the Bangladesh Bank (BB)'s Monetary Policy Statements (MPS) indicated it is considering adopting a crawling peg system.

However, the timeline for implementation and a technical methodology have not been announced, said the report.

The World Bank report suggested that exchange rate reforms are urgently needed to rebuild the external buffers.

"The reform would also help ensure sufficient foreign exchange liquidity, essential for fulfilling debt service and other external payment commitments."

"Significant downside risks to the outlook stem from delayed implementation of external and financial sector reforms. Delays in exchange rate reforms can result in continued depletion of international reserves to critically low levels," according to the report.

The World Bank report also said inadequate supply of natural gas during the peak season and the inability to import sufficient LNG due to foreign exchange shortages can disrupt industrial production and investment.