The banking sector in Bangladesh has been rated as "extremely high" in risk because of weak governance in some banks and high bad loans.
S&P – a global credit rating agency – has placed Bangladesh's banking sector in group "9" among its 1-10 groups in the latest rating report, where one represents the highest assessment and 10 the lowest.
The report entitled "Banking Industry Country Risk Assessment: Bangladesh" was published on Tuesday (24 November) for the year 2020.
The economic risk of Bangladesh deteriorated by one notch from group "8" in 2018 and has remained stable since last year.
"Bangladesh's credit risk remains extremely high, with weak foreclosure laws and underwriting standards, weak governance at some banks, and client concentration leading to sizable stressed assets in the banking industry."
Foreclosure is a legal process that allows lenders to recover the amount owed on a defaulted loan by taking ownership of and selling the mortgaged property.
"Bangladesh is implementing international regulatory standards. However, we believe supervision has gaps and imposes limited market discipline," said the rating agency.
"Weak asset quality and capitalisation of some banks in the country reflect gaps in monitoring and in the ability to address problems early. In our view, the banking system has overcapacity and market distortions. A supportive core customer deposit base and low reliance on external funding temper these weaknesses."
However, the rating agency sees stability in the economic risk trend.
"In our opinion, Bangladesh's low-income economy, heavy development needs, and fiscal constraints limit its economic resilience.
"That said, the country has healthy growth prospects and moderate economic imbalances, with credit growing in line with nominal GDP, and benign inflation and current account positions."
"A rebound in the export-focused manufacturing sector supports growth prospects. We believe capitalization and asset quality for banks will continue to remain extremely weak but disguised by high levels of regulatory forbearance, especially in the wake of Covid-19."
"Bangladesh's industry risk trend is stable. We expect the central bank to continue to readily offer regulatory forbearance. Reforms in Bangladesh are taking a back step in light of the pandemic, similar to many countries."
"We expect a return to the reform agenda to be slow in the wake of a significant overhang of bad loans. We expect Bangladesh's strong deposit-driven system wide funding to remain a relative strength."
Earlier in October this year, Fitch Solutions projected a rise in bad loans in the Bangladesh's banking industry after the expiry of regulatory forbearance given considering the pandemic situation.
Banks' profitability would further worsen as soon as the facility of paying loan instalments expires because the banks will have to keep aside a huge amount from their earnings as a provision against default loans, observed Fitch Solutions.
The observation came in a report entitled "Covid-19 Woes Perpetuating Weakness of the Bangladesh Banking Sector".
The report also said non-performing loans would increase following the deferment facilities given by the Bangladesh Bank, especially when it comes to a weak economic environment.
As part of its crisis mitigation strategy, the Bangladesh Bank on 19 March this year primarily directed banks to provide instalment deferment facility to all borrowers for six months – from 1 January to 30 June. Later, the facility was extended in two phases till December.
However, banks did not get a waiver from maintaining required provision against default loans.
Bankers said default loans in the banking sector will be stable this year, but it is likely to jump next year when banks will restart loan classification.
The rise in default loans will hike the provisioning cost for the banks which will ultimately hit their profitability.
A loan loss provision refers to funds set aside by a bank to cover bad loans – the ones that do not get fully repaid because the customers default on their payments.
According to the central bank's recently approved data, the total amount of defaulted loans stood at Tk96,116 crore at the end of June last, which was 9.16% of the total disbursement and outstanding loan of 59 banks operating in the country.
Most of the default loans in the financial sector have turned into bad loans which means those are unrecoverable, according to a recent research of Bangladesh Institute of Bank Management (BIBM).
Bad loans accounted for 83.2% of defaulted loans in 2018, which increased to 86.3% in 2019, said the BIBM.