Weak institutions challenge to next phase of growth financing: WB

To reach the next stage of development, Bangladesh will require $608 billion investment in infrastructure by 2040. As it will not be possible for the government to provide the entire investment, large investments by the private sector will be needed, according to the World Bank (WB).

But the Washington-based lender notes that it will be difficult to meet the investment demand by the private sector, owing to severe financial sector mismanagement, liquidity crisis in the banking sector and the government's excessive dependence on domestic debt.

The World Bank in its "Bangladesh- Country Economic Memorandum: Change of fabric" report, which will be officially released on Thursday, also points the finger at an inconsistent ratio of gross domestic product (GDP) and banking sector credit flow.      

According to the Planning Commission, an annual $66.32 billion resource gap in achieving the Sustainable Development Goals (SDGs) will scale at $928.48 billion up to 2030. The estimation recommended a plan to manage 51% of the gap financing from the non-state actors.

The Asian Development Bank (ADB) also recommended ensuring investment for infrastructure from the Public Private Partnership (PPP) modality of at least 1.8% of GDP, or around $5 billion in each year.

But in the latest World Bank report, Bangladesh's performance in the financial development index points to a disappointing situation in the financial institutions. 

According to the report, Bangladesh scored only 0.24 points out of a total score of 1 in the financial development index of the World Bank and the International Monetary Forum (IMF) in 2020, slightly lower than the 1999 score of 0.25 points.

Bangladesh secured the 95th position out of 184 countries in terms of financial development, slightly above lower-middle-income economies, but below upper-middle-income economies.

The World Bank stressed that reforms to improve the financial sector as an aspiration to reach upper-middle-income status by 2031 cannot be achieved through financing sourced from the public sector alone.

"Comprehensive reforms are required to enhance financial sector intermediation capacity to support economic growth while preserving financial sector stability," notes the report.

Reforms yet to catch up with aspirational peers

Financial sector reforms in the country started in the mid-1980s through the work of the Money, Banking and Credit Commission, including the denationalisation of banks, licensing of private commercial banks, use of back-to-back letters of credit, and introduction of micro-credit for the poor, ‍said the World Bank report.

The reforms accelerated in the early 1990s with interest rate deregulation, restructuring of the banks' operational procedures, and introduction of a loan classification system and provisioning framework as well as capital adequacy standards, it notes.

According to the World Bank, in the late 1990s, the reforms continued with improvements in the regulatory and supervisory framework of banks, assigning greater powers to the Bangladesh Bank. Bangladesh also progressed in adopting the Basel regulations, with the introduction of risk-weighted capital adequacy minimum requirements in 2007 as well as other prudential norms.

Further, to improve financial inclusion, the Credit Information Bureau (CIB), established in 1992, was automated in 2009. More recently, transformational advances have been made in the areas of digitisation and payment system infrastructure.

"Despite this remarkable progress, in the development of financial institutions and financial markets, Bangladesh still lags behind its structural and aspirational peers," the report added.

Lowest regulatory capital among peers

Banks in Bangladesh have the lowest regulatory capital among the country's peers, driven by undercapitalisation of the state-owned banks, reveals the report.

It said that Bangladeshi banks had a capital-to-risk-weighted assets ratio (CAR) of 11.6%, substantially below all the peers. The CAR in China is 14.64% and in India is 15.42%. The rate in Cambodia, Thailand and Indonesia is 21.77%, 19.35% and 23.31% respectively.

State owned banks, both specialised development banks and state-owned commercial banks, are severely undercapitalised, according to the report. 

It said the rate for state-owned commercial banks was 4.3% in 2020 below the regulatory minimum requirement of 10%.

The World Bank said that the specialised development banks in the country are deeply insolvent, with a negative CAR of -32.9% in 2020 down from -7.8% in 2012.

The report said the quality of bank assets in Bangladesh is weak and profitability is low, especially for state-owned banks. The levels of non-performing loans are underreported due to the lax legal definition of default and long-standing generous rescheduling and restructuring policies.

The lower quality of assets and high operating costs have led to bank profitability decreasing in Bangladesh, which leads to the lowest rate of return on assets in Bangladesh at only 0.68%.

The weaknesses of banks, and especially the high load of non-performing loans, reduced the ability to supply credit for the private sector, which dumped the credit-to-GDP ratio below 45% in Bangladesh, above only Indonesia. The rate is above 100% in China, Vietnam, Cambodia, and Thailand.

Fraudulent schemes with directors involved 

The World Bank identified that the board of directors of several banks were appointed from non-financial firms, political leaders and owners of business groups.

It said although some restrictions on related-party transactions exist on paper, the regulations are not consistent with international best practices and, in practice, there are few barriers to self-dealing.

For example, the report said, to circumvent the Bangladesh Bank's prior approval of loans to directors exceeding a certain amount, directors can borrow from banks other than the one for which they are directors, so as not to be classified as related parties. 

"This phenomenon has reached an alarming size, with at least 20% of the total loans in the banking system being granted to directors," says the World Bank report.

When facing financial difficulties, directors are incentivised to borrow from other banks, directly or through family members, to regularise their position, to avoid termination of office, causing evergreening of loans, it added.

The report highlighted various fraudulent schemes over the past decade, with the involvement of members of the board of directors in Sonali Bank worth losses of Tk30 billion, BASIC Bank Tk45 billion, and Padma Bank, formerly Farmers Bank Tk30.7 billion.

Needs a major restructuring 

The report advocates a major restructuring and deepening of the financial system, including increasing the efficiency and sophistication of the banking sector, and developing a long-term capital market. 

The World Bank believes the country needs to source external resources proactively, including through international capital markets, by promoting local currency financing, easing external borrowing constraints, and attracting foreign direct investment. 

According to Prof Rashed Al Mahmud Titumir, chairman of the development studies department at Dhaka University, financial irregularities erode the lending capacity of banks.

The economist said many are defaulting on bank borrowing due to loan approval without proper verification. Instead of any punishment, big defaulters are often awarded different facilities, which demotivate the good customers.

Although there are many initiatives and laws to discipline the financial sector, those are only on papers, he commented.  

As an example, the prof said that despite signing the Basel III Accord, none of its main three pillars – market discipline, supervisory review process and minimum capital requirement – is being followed.