Bangladesh, often dubbed a 'tiger cub' for its exemplary economic growth, was 95th among 184 countries in the September 2022 edition of the World Bank's Global Financial Development Index.
The index factors in many variables, such as the number of bank accounts per 1,000 adults, bank branches per 100,000 adults, percentage of firms with access to credit etc. to assess the degree of financial inclusivity and potential for investment generation in a country.
Bangladesh, a lower-middle-income country itself, is positioned slightly above other lower-middle-income economies but below upper-middle-income economies.
Given Bangladesh's aspiration to become a developed country by 2041, its performance in developing its financial sectors - a crucial driver of investment - remains underwhelming, to say the least.
On top of that, the country faces a reckoning as it is scheduled to graduate from the category of Least-Developed Countries (LDC) in 2026. Bangladesh's economic growth, driven by its export-oriented RMG sector, will face considerable preference erosion in European markets, as it will no longer receive duty-free access under the Everything But Arms (EBA) initiative.
Most economists have argued in favour of bolstering the country's financial sectors to foster increased investment for high value-added products. However, one scandal after another and a concerning rate of non-performing loans leave much to be desired from the country's financial sectors. On top of that, poor corporate governance, lack of transparency and regulatory independence exposes the financial sector to avoidable risks, a recent World Bank report finds.
However, without a functional financial sector, Bangladesh may find it difficult to generate the level of investments sufficient to face the challenges posed by LDC graduation and avoid being caught in the Middle Income Trap.
The Business Standard spoke to Dr Ahsan H Mansur, Executive Director at the Policy Research Institute, to discuss the implications of a weak financial sector for the growth prospects of the economy.
According to the global Financial Development Index, Bangladesh was 95th among the 184 countries included. Do you believe this is satisfactory?
The initial condition of Bangladesh's financial sector was terrible. Back in the 1970s, the depth of the financial sector, as measured by broad money (M2) over GDP, was only around 20%.
Over the years, with the introduction and expansion of the private sector banks in the mid-80s, access to finances considerably improved. The broad money over GDP ratio reached the peak of about 60-63% of broad money. However, the depth of the financial sector remains unsatisfactory. For example, the M2 over GDP ratio for India and China is around 100% and 200%, respectively. For Bangladesh, the ratio should be somewhere around the 100% mark.
If we look at other indicators regarding the financial sector, the banking sector is the best performing. The financial sector can be divided into four sectors: the banking sector, the stock market, the bond market and the insurance market.
Globally, the money or banking market is, which is 174% of the global GDP. The bond market is about 140% of the global GDP, it is higher in industrial countries. In the United States, the ratio might be over 200%. The stock market is 120-125%. Insurance is relatively smaller, constituting only 12-15% of the global GDP. Bangladesh's insurance market is less than 2%. The size of our bond market is about 4%.
The situation in the financial sector is very precarious compared to the global market. We don't have any sophisticated financial products. We do not have a forwards market no forward exchange in the commodity market. No hedging policy to mitigate exchange rate risks. The development of a secondary market was not allowed in this country. Part of it has to do with tight regulations.
Financial inclusion and expansion have crucial growth implications as the financial sector expands, the economic agents' access to finances increases and makes investment more convenient. Recently the M2 over GDP ratio for the banking sector has declined to 55% from over 60%, which is rather unusual for a developing economy like Bangladesh.
How would Bangladesh's stagnant private sector credit growth affect Bangladesh's prospects after LDC graduation, given that exports from the country might face preference erosion in the international market?
While it is often claimed that Bangladesh is an export-driven economy, that is not necessarily the case. To this day, the most significant component of Bangladesh's GDP is consumption. That is, most of the GDP stems from the domestic market. And access to finances is crucial in boosting the domestic market.
That is not to diminish the role of exports. Bangladesh needs to address both its internal and external inefficiencies sufficiently to survive and thrive in a post-LDC landscape. In terms of boosting exports, Bangladesh can sign some form of preferential trade agreement with its largest trading partners to mitigate preference erosion. Moreover, it needs to address inefficiencies in its transport logistics, shipping and border posts as they increase the lead time to export. For instance, to export a given quantity of products, Bangladeshi exporters require three months of lead time, whereas Vietnamese exporters can do it within a month only because of having more efficient ports. Bangladesh can reduce the lead time by improving the conditions of the backward linkage industries as well.
According to a recent report by the WB, weak corporate governance, poor regulatory enforcement and lack of transparency expose banks in Bangladesh to significant risks and abuse. Would you like to share your comments on this finding?
These are all established facts and there is no point in disputing these findings. What's more important is to address the underlying factors, political or otherwise, that lead to weak governance or lack of transparency.
As one of the underlying factors, the report mentioned the incorporation of the independent director just for compliance reasons and that they hold no significant power whatsoever. How serious a problem is this?
There are lots of issues with the nature of gatekeeping in Bangladesh's banking sector, whether it is about selecting independent directors or granting permission to open a new bank. For instance, every director in the state-owned banks was an independent director, many of whom were previously government employees and did not hold ownership of the banks' assets.
However, political leaders and other discretionary forces often influence the decisions taken by the directors, which end up exposing the banks to financial risk, as we have seen in the case of Basic Bank.
But the gatekeepers need to play an even more crucial role in giving permits to banks and non-bank financial institutions. The regulatory authorities need to investigate and analyse the source of the funds that are being used to open the bank, whether the owners are fit to own a bank, whether the fund is legal and how sustainable and feasible opening the bank would be. Unless you prevent suspect owners from opening new financial institutions, it becomes difficult later to rein them in.
Unfortunately, the government, Bangladesh Bank and the regulatory authorities are aware of these problems. But there is considerable political motivation not to take action against these banks and their suspect owners.
Moreover, it is a complete misnomer that simply increasing the number of banks would improve access to finance. Most of the banks operate in centres of commerce like Motijheel, Gulistan, and Gulshan. Smaller banks are often unable to branch out to peripheral regions most in need of finances.
To make matters worse, a large number of banks and non-bank financial institutions are difficult to monitor for the central bank.
The report also identified non-performing loans as one of the major issues in the banking sector. Why does this problem continue to persist?
The governance issues I mentioned earlier culminated in the crisis of non-performing loans. These irregularities are reflected in the banks' profitability as well. The bank owners are not concerned with the profitability of the banks. They primarily care about their profitability. And the lack of corporate governance makes investing in a bank a lucrative business venture.
The report also discusses the Ministry of Finance directly or indirectly intervening in the decision-making process of the central bank. Should the central bank be allowed more independence in policy formulation?
I believe the problem lies with leadership. The leaders of the central bank do not exercise the power they have been awarded by law. They can set the exchange rate and interest rates as they please as long as the decision is backed by a sound understanding of macroeconomic conditions.
If the governors of the central bank do not take initiative and keep waiting for the government's decision before taking any decision, awarding further independence would not bring about a fruitful outcome.