Our banking system is currently passing through a critical financial phase due to some problems accumulated over the years. The problems have been kept intervention-free for a while hoping that the system will find its own way out. However, the situation seems to go from bad to worse. Banks have started fiercely competing for deposits provoked by their own capital crunch coupled with a liquidity problem. Resultantly, bank officers at different levels are given a deposit target each which, in turn, creates an unhealthy competition among banks and their colleagues. Depositors' trust in the overall banking system has started to wane. Amidst these adversities, the finance minister has stepped in to ameliorate the situation by reducing the cash reserve ratio (CRR) from 6.5 per cent to 5.5 per cent. The package is also accompanied by a proposal to deposit 50 per cent of the government funds with private commercial banks.
CRR is basically the reserve the central bank requires the commercial banks to maintain with it in addition to the statutory liquidity reserves (SLR) so that all the deposits are not doled out. In case the central bank does not require CRR and SLR, commercial banks may lend all the deposits available with them. In such circumstances, any default on the borrower's side would put depositors at risk. Thus, reserve requirement works as a trust building element between the national banking system and the depositors. Banking is one of the critical sectors which require utmost trust of the society. Reducing CRR is just a blow to this trust at a time when it is required most. In addition, the reserve requirement functions as a monetary policy tool. It is essential to address the trouble of the banking sector but the way it is dealt with is believed to have an ill-effect on the society. In particular, reducing CRR is expected to create an upward pressure on inflation.
Although there is a lack of consensus as to what should be the appropriate rate of reserve requirement, slashing CRR is not going to be the panacea for the accumulated mess of the banking sector. In general, if an economy is in upward trend and the financial system is sound owing to positive responses of other macroeconomic elements (low rate of inflation, high employment), an expanding mode of private investment accompanied by higher GDP (gross domestic product) growth may justify the adjustment in the CRR and the central bank may consider relaxing the reserve requirement. However, the current move under the given financial condition is unlikely to pay off.
Slashing CRR, given the widely accepted view that the central bank is the last resort for commercial banks, proves that the government has wound up other effective weapons to fight the ongoing financial mess.
The current turmoil in the banking system is the result of the moral crisis. The problem of moral bankruptcy stems from multifaceted sources in the banking system of Bangladesh. Increased competition, frequent government interventions, lack of tougher actions against voluntary loan defaulters are none but few examples which bred the moral hazard.
It started with the state-owned banks (SOBs) which were frequently rescued injecting taxpayers' money because of banks' apparent inefficiency. At the end of 2017, default loans of three SOBs amounted to Tk 289.53 billion (28,953 crore). Arguments have been raised that SOBs have financed state-owned enterprises (SOEs) which were not able to repay their debts. Historical analysis shows that some sectors of SOEs including petroleum, jute, textiles, and newspapers were among the top loan defaulters of SOBs. Some of these enterprises are now defunct and the rest were restructured again at the expense of taxpayers' money. This 'policy lending' gives SOBs an excuse not to vigorously work on screening and monitoring of borrowers. Similarly, they are not vigilant enough in recovering their problem loans. A clear moral hazard symptom exists here.
Second, introducing new banks has intensified the competition. New banks have been allowed to start their operations without analyzing their economic viability. Without a comprehensive feasibility study, these banks were given licences merely based on political consideration. Lacklustre performance of most new banks provides vivid evidence that these banks were unwarranted.
No doubt, these new banks have increased the competition in raising the standard of customer services. Competition is easy to praise but difficult to understand as far as the banking sector is concerned. Not so long ago, banks in the USA, supposedly the most unfettered and sophisticated market system in the world, were heavily restricted especially in regard to geographic expansions and lending. Excessive competition between and among the financial intermediaries results in financial fragility. That's what the new banks brought in Bangladesh. Instead of expanding their operations in an unserved segment of the economy these banks compete to share the existing pie, instead of significantly augmenting it. This leads to the rise in loan concentration which ultimately results in the risk exposure of banks to some particular borrowers.
Third, the moral hazard skyrockets, when the culprits go unpunished. After all these recent financial scandals including Bismillah Group, Hall Marks, Farmers Bank, and Basic Bank there was no discernible action against those who were responsible. This inaction has an important repercussion for the banking system in the sense that it would encourage voluntary default.
Instead of sealing the sources of these problems the government intervention with the available tools to adjust with the situation would undoubtedly encourage these perpetrators to venture more for such occurrence in the future. We should note that such adjustments may add a positive impetus in the short-run, but they may experience the 'boiling-frog syndrome'. The frog may survive for some time in the boiling water by adjusting its body temperature despite being capable of jumping out. At one point the water temperature rises above the absorbable level when the frog wants to jump out but of no avail, because it is too weak to jump. Similarly, the government's frequent intervention instead of addressing the root of the problems will leave it with fewer options to adjust in the future in which case the banking system may face a systemic collapse.
Dr. Mohammad Dulal Miah is an Assistant Professor and Head of the Department of Economics and Finance at the University of Nizwa, Oman
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