Defaulted bank loans in Bangladesh and the IMF

Bangladesh was supposed to implement its new loan reclassification policy as of first April. Now it seems that because of the vulnerabilities of the banking sector, Bangladesh Bank will renegotiate the programme with the International Monetary Fund (IMF), a mission of which is in the capital now. The new policy would declare a loan as defaulted, if it is not paid within three months of the due date. Earlier, the time limit was six months. The new loan classification policy is consistent and compatible with the global Basel III Banking Regulatory Policy. Bangladesh initially agreed to implement this new loan reclassification policy as a condition for the $2.7 billion loan that it received from the IMF in 2023.

Bangladesh is not alone in requesting a postponement in the implementation of the Basel III Banking Regulation Policy.  The United States (US), the United Kingdom (UK) and the European Union (EU) have also requested for more time in implementing this policy. The United States will start its implementation from July this year with a three-year transitional period. The European Union will also delay the process so that their medium-sized banks are not under pressure. All these events may strengthen the position of Bangladesh with regard to the renegotiation of its loan reclassification policy.

Currently, the amount of defaulted loans is on the rise in the Bangladesh economy. At the end of 2024, defaulted loans of the country stood at 20 per cent of the total disbursed loans. Only a year ago, in 2023, the ratio was 8 per cent. During the period 2023 -2024, the defaulted loans in Bangladesh have increased by Tk 2 trillion, bringing its total to Tk 3.6 trillion by end-December, 2024. The Bangladesh Bank projects that the ratio of defaulted loans in the country may rise up to 30 per cent of the total disbursed loans, and in absolute terms, it may surpass Tk 5 trillion. A weak regulatory framework, persistent inefficiency in the financial system, illicit money laundering and capital flight have all contributed to increases in defaulted loans in the country.

The increases in the defaulted loans may impede the implementation of the new loan reclassification policy of the Bangladesh Bank. If the country returns to the global definition of defaulted loans, the defaulted amounts may rise, and it may be more difficult to conform to the IMF conditionalities. The IMF conditionalities require Bangladesh to decrease the ratio of defaulted loans to total disbursed loans to 10 per cent for public banks and to 5 per cent for the private banks. All these are linked to the February 5 release of the third tranche of the IMF loans. That date has been postponed without any explanation.

On the other hand, because of the deterioration of the country's banking sector's asset quality, Moody has downgraded its rating of the future of the banking sector of Bangladesh. Further tough loan classification policy will make the current situation more complex. Given the country's economic sluggishness and its high inflation, a higher number of entrepreneurs may not be able to pay off their debts.

In fact, in 2012, Bangladesh adopted the global standard for loan reclassification to identify the country's defaulted loans. According to that standard, if after three months of the stipulated time, a loan is not paid off, that becomes a defaulted loan. But in 2019, that standard was relaxed and the relevant dead line for loan repayment was extended from 3 to 6 months. But in reality, the debtors used to get about 9 months to repay their loans. Furthermore, in 2012, because of the policy of refixing of the time period for repayment of loans, the defaulters could reclassify their loans for three successive times. That process helped the defaulters to hide their bad assets.

There were, however, many reasons for such phenomena. But the biggest reason was to provide undue and illegal advantages under the state patronage to a few vested interest groups. With the state saving their backs, these interest groups used the banks as their private coffers. By breaking the rules and regulations of all economic disciplines, they dominated the management boards of different banks, controlled the management structures of these financial institutions.  And as such, they institutionalized a permanent system of stealing money and money laundering from the banking system, where there were no structures of transparency and accountability. There were dual outcomes of the process - non-repayments of loans amounting crores of taka and laundering abroad the money and resources representing the defaulted loans.

There is no doubt that because of all these deviations, huge amounts of defaulted loans could be hidden on paper, but ultimately, it devastated the financial wellbeing of the country. As a result, during the last decade, 10 banks were on the verge of collapse. Along with it, billions of taka were laundered outside the country. In spite of all these wrong-doings, the foreign credit rating institutions did not downgrade the rating of our financial institutions. Yet, because of the rapid soaring of defaulted loans as well as the ensuing tough implementation of the policies, in future, there may be downgrading of these ratings. The outcome of the Bangladesh-IMF negotiations will have an important impact of the future stability on our financial system. Balancing between the rules and regulations of the regulatory system and the economic realities on the ground would represent a big challenge for Bangladesh.

Dr Selim Jahan is former Director, Human Development Report Office and Poverty Division, United Nations Development Programme (UNDP), New York, USA. jahan.selim@gmail.com