As a developing economy Bangladesh has encouraged to develop its banking industry to promote economic growth. Over the last three decades or so the country has seen spectacular expansion of the banking industry. The banking industry in Bangladesh has even gone a step further by promoting financial inclusion of the very poor in rural areas of which microfinance and microcredit are the policy instruments to achieve that objective. This has helped to expand the monetisation of the rural economy, and as a consequence it has become more market-oriented. Such market orientation of the rural economy also facilitated continuous resource transfer from rural areas to urban areas. Now the biggest threat to achieving sustained economic growth has become the banking industry itself, especially the state-owned banks. This is despite Bangladesh adopting internationally recognised banking practices such as Basel III Accord.
The increased financialisation of the Bangladesh economy also created an environment where huge wealth has been accumulated by a section of the rich by defrauding banks, in particular state-owned banks. It is generally suggested that the stock market scams in Bangladesh are most likely to be linked to this fraudulent financial practice with the ultimate goal of acquiring control of various listed companies by bankrupting small investors.
The legal system also plays a distinct role to enable owners of capital to consolidate and expand their wealth as we have seen in the post-GFC (2007-2008 Global Financial Crisis) period in developed economies. A capital-friendly legal bias is quite evident in market-oriented economies in both developed and developing economies. Even the central bank of Bangladesh - Bangladesh Bank, was a target of robbery in February 2016 where US $101 million were stolen from its account with the Federal Reserve in New York. No clear picture is available still now who were involved in the heist and where the money has ended up. The heist has been described as one of the biggest bank robberies in history. It appears that this is not the only time money has been stolen from Bangladesh Bank. A senior official of the bank was convicted in February this year for stealing money from the bank. But what is surprising that it took almost 21 years to resolve the case.
Bangladesh's banking system is now faced with a slow-motion banking crisis principally at the government-run banks along with some private sector banks. The Finance Minister himself last month said the current banking and non-banking financial sectors are in the most vulnerable position. The situation is anything but getting any better largely due to very fast credit growth and state directed lending and loan restructuring. All this raises the risk of a credit crunch. Six state-owned commercial banks account for almost a quarter of all bank assets in the country. The government appoints their chief executives and board members and often influences them to activities with disastrous effects.
The state appears to want to have pliant banks who will listen to their diktats to lend to such areas as infrastructure projects and to buy government bonds. But far more odious is the collusion between business and political elite in influencing state-owned banks' loan allocations in their favour and these are the ones most likely to get defaulted. The result is a huge amount of nonperforming loan (NPL) now estimated to be in excess of Tk 1.0 trillion (US$ 12 billion) (FE, 18/2/19). And half of it is owed to six state-owned banks requiring continuous recapitalisation of these banks with tax-payers' money. The rest are owed to private and foreign-owned banks. The share of NPL now stands at close to 11 per cent of the total loan portfolio. When restructured and rescheduled loans are included, the share of NPL goes up to about 20 per cent.
The term NPL can be a contested term in the context of Bangladesh in the sense that loans are not performing in the businesses loans were allocated for, therefore business enterprises defaulted or close to default. Technically, a loan becomes a NPL after being in default for 90 days. But in Bangladesh loan obtained for a particular business activity can be channelled into some other business activity and performing very well there or into Benami properties, worse even money might have left the country altogether and invested in properties overseas or in an offshore bank account. After all, if one steals money from banks, in particular from state-owned banks, the person does not want lose his/her ill-gotten money to someone else's scam or confiscation by the state. Therefore, a more accurate term under the circumstances is "debt default''. A debt default shows that a bank has difficulty in collecting interest and principal payments and that may lead to profit squeeze, or even the closure of the bank.
To understand the consequences of debt defaults one has to clearly understand how commercial banks operate. A bank does not lend money, but creates money when it advances loans. The bank has converted one asset (cash) into another asset (the promise of repayment). But the loan now has added an additional amount of money. And that is how banks create money. When banks create money through lending, they only rely on borrower's ability to repay the loan with interest when it is due. However, banks' ability to create money is constrained by capital. In contrast, a Central Bank's ability to create money is constrained by willingness of the government to back it and the ability of the government to tax the population. But in practice most central banks create money using their assets. They create new money when they buy new assets in open market operation or QE and when they lend to banks.
Banks also create money when they buy assets whether real or financial. Joseph Schumpeter in his book History of Economic Analysis about 60 years ago said "it proved extraordinarily difficult for economists to recognise that bank loans and bank investments do create deposits'' i.e. create money. When a loan is extended to a customer, the bank simply opens an account for the customer with the agreed loan amount in the account. The customer signs a legally enforceable contract to repay the loan with interest within a stipulated timeframe. This constitutes a future income stream for the bank. Now it is crystal clear that no money has been taken out of any other account or accounts. The bank itself does not have any money, but opening the loan account, it now has created money. If the borrower defaults, it becomes a bad debt, if bad debt continue to rise the bank will become insolvent and close its doors or must receive bailout from the government. When such a situation extends to the whole banking industry in the country, a credit crunch ensues resulting in rises in interest rates (interest rates in Bangladesh now vary between 13-15 per cent) leading to a downturn in the economy. There is a saying that if one owes one million dollars to the bank the person has serious problem, but if he/she owes 100 million dollars to the bank, then the bank has a serious problem, and if the person owes 1000 million dollars to the bank, then the whole country has a serious problem at hand.
According to Bangladesh Bank, by the middle of 2018 seven state-owned and three private sector banks were running capital deficits, that necessitated state-funded recapitalisation or bailouts of these banks to maintain public confidence in the banking system. But such bailouts will create moral hazard problem and likely to encourage banks to continue with such behaviour. State also must refrain from directing lending to certain specific sectors or purposes and such activities can better be undertaken through budgetary provisions. The existing regulatory capital requirements to ensure banks remain financially viable have not yielded the desired results as reflected in many banks experiencing capital inadequacy. That raises the question whether those requirements are fit for the purpose. If that is the case they ought to be revisited. The banking regulatory regime in Bangladesh also at the same time should focus on mitigating the risk of misconduct and must assess the culture drivers of misconduct. As for the banks themselves, they must put in place effective credit risk management to ensure loans are matched with ability to repay and used for the purpose these were intended for and must forestall any insider lending and mitigate any information asymmetry.
Muhammad Mahmood is an independent economic and political analyst.
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