In June 2016, Bangladesh Bank published its seventh annual assessment of the nation’s banking sector. It was like every other one of its kind: worthy, wordy, and packed with a dizzying array of data analysing the asset quality of local lenders and non-bank financial institutions.
This time, however, it contained a bonus surprise. Along with a section on non-performing loans, the central bank added a chapter devoted to bank loans that had been either rescheduled or restructured, and which would under normal conditions be considered non-performing.
The numbers proved quite an eye-opener. While the ratio of overall gross NPLs – non-performing loans as a share of total loans – came in at 8.8%, down from 9.7% the previous year, once Bangladesh Bank factored in restructured and rescheduled loans, that ratio mushroomed to 16.1%, a rise of exactly 300 basis points in a single year.
This is not a new problem. Domestic banks have beeín rescheduling or restructuring loans for years. State lenders in particular are, analysts say, experts at helping debt-riddled corporates find new ways to free wheel on repayments or at working behind the scenes to overhaul entire loan facilities.
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But by including this additional set of data, Bangladesh Bank was venturing into unknown territory. It was admitting to a problem widely recognized within the nation’s financial circles as a serious, structural issue – yet one that everyone was wary of publicizing, for fear of political retribution.
By releasing the cat from the bag, the central bank was giving lenders, regulators and politicians the chance either to tackle the problem at source, or to bury their collective heads in the sand, in the hope that the issue would resolve itself.
So far at least, most voices have opted for the safer option of silence. True, a few influential people have been banging this drum for years. In its latest Bangladesh Development Update, published April 2016, the World Bank warned that the positive ramifications of rising economic output were being tempered by persistently high levels of NPLs, which, it said, “increased banks’ operating and funding costs, keeping interest rates high despite large excess liquidity”.
During a recent trip to Dhaka, Asiamoney met with the chief executives of several of the country’s leading private banks, as well as a few state-run lenders. All acknowledged their concern.
“Rising NPLs are a problem, no doubt about it,” says the CEO of a large private-sector financial institution, who prefers to speak off the record. “Everyone knows most banks under report [NPLs], but until the problem is officially recognized by the government, the banking industry cannot get serious about it. No one wants to be the first one to move.”
For its part, the central bank is clearly hoping to force the financial industry to recognize its own, glaring deficits. In its latest Financial Stability Assessment (FSA) Report, spanning the third quarter of the calendar year 2016, it warned that the gross NPL ratio was on the march again, reaching 10.3% at the end of September 2016, against 8.3% nine months earlier.
It noted that of the country’s 56 banks, 12 have stressed-loan ratios of more than 20% of their loan portfolios, while 12 others had stressed-loan ratios of between 10% and 20% of their overall book. Of this gang of 24, just five banks are privately owned. According to central bank estimates, at the end of September 2016, 64.8% of all NPLs were held by the nation’s 10 largest lenders by assets.
Fazle Kabir, who replaced Atiur Rahman as central bank chief in March 2016, following an audacious heist that involved cyber-thieves stealing more than $100 million of the country’s foreign currency reserves, has been a vocal critic of the country’s less financially virtuous lenders. At a February 2017 meeting of the Metropolitan Chamber of Commerce and Industry, the country’s oldest trade organization, Kabir lambasted the country’s state banks for the sharp recent rise in soured loans, calling the problem “alarming”.
Kabir also called out six leading state lenders – Sonali Bank, Janata Bank, Agrani Bank, Rupali Bank, Basic Bank, and BDBL Bank – blaming them for a sharp recent rise in lending rates. The central bank chief pinpointed one of the underlying causes – the tendency for big banks to favour a few, big domestic corporates by channelling extra capital in their direction. Kabir noted that 40% of Janata Bank’s loans had been disbursed to just nine big industrial groups. “This is unacceptable,” he thundered at the meeting.
Some in the room that day may well have raised their eyebrows in surprise at this reproach. Kabir has been a bold critic of the bad-loan problem. But he was less vociferous in his former guise: before joining the central bank, Kabir was chairman of Sonali Bank and a member of the board of directors of Janata Bank.
And the banking sector’s problems run wider and deeper. Look beyond the topline data and you see an industry unprepared for the challenge of supporting the burgeoning financial, economic and personal needs of a highly populous and fast-growing young nation. Too much working capital is channelled into the hands of the biggest industrial groups.
“Thirty very large corporations in this country control between 60% and 80% of the total loan book,” said Selim Hussain, CEO and managing director of Brac Bank, which specialises in lending to small and medium-sized enterprises. “Why would I want to do business with big companies that bequeath us only NPLs and very thin margins?”
Asif Khan, a Dhaka-based research analyst at frontier market investment specialist Exotix Partners, notes that too “many banks are badly managed and governed”.
Some lenders, to be fair, are a credit to themselves. The likes of The City Bank and Brac Bank are well-run and assiduous about reporting their real non-performing loans ratios. Eastern Bank has one of the sector’s best balance sheets, with an NPL ratio of 2.69% at the end of 2016.
But not all private-sector players are as virtuous or financially vigorous – some are as bad as their state-run peers. “What many people miss is that there are also private commercial banks where true NPLs have reached alarming levels and are grossly under-provisioned,” notes Exotix Partners’ Khan.
ICB Islamic Bank is a case in point. The lender has struggled for traction for most of the last decade. It had a capital shortfall of $183 million at the end of September 2016, the end of the last full financial year, while its capital adequacy ratio stood at negative 108.49%.
But blame is one thing. Finding solutions to seemingly intractable problems is quite another – just ask the politicians and regulators striving to wrest Japan from its near-30-year malaise. Bangladesh’s banks are not in the invidious position of being forced to lend to big nation-building infrastructure projects, many of which have no hope ever of turning a profit or repaying their debts, as is the case in, say, China or Vietnam.
In Bangladesh the issue is more nuanced, but often just as political. Too many lenders lack proper credit underwriting policies. They often “prefer to lend to ‘their own’” – often wealthy business owners with strong connections to one of the country’s two main political parties, and who have little or no intention of ever meeting their loan repayments – says one industry insider.
To upstanding bankers, this might sound incredible, even ludicrous. But some state banks have little choice in the matter, experts say. If a leading corporate refuses to meet his obligations, his bankers are typically left with one of two choices. They can shrug and roll over, restructuring or rescheduling any loans. Or they can they can report the delinquent borrower.
This is the nuclear option, one that is rarely used. “I once asked the central bank why they don’t force more lenders to publicly disgrace their most reliably delinquent borrowers,” says one Dhaka-based banker. “The answer came back: ‘Because to do so would be to lead to one bankruptcy, then more of them, and as companies fail, the unemployment rate would rise’.”
Under local law, once a corporate’s loans are in default, its parlous financial state has to be reported to the central bank’s Credit Information Bureau. From that moment, the firm in question cannot secure any financial facility from an onshore or offshore lender.
For their part, lenders are loath to report debtors, for the simple reason that to tally a loan as non-performing would push their provisioning levels up and capital adequacy down.
Exceptions to the rules
There are exceptions, moments when corporates’ excessive and continuous delinquency is called out. In October 2016, the BTRC, Bangladesh’s telecoms regulator, suspended the operating licence of mobile carrier Citycell for failing to meet loan obligations and government debts of Tk4.77 billion ($60 million). Citycell, 44.5% owned by Singapore-based carrier Singtel, had been delinquent on its debts for years. Yet within 17 days, its operating license was renewed and returned, after the carrier made a Tk1 billion payment to the regulator.
Curiously, despite clear evidence of rising volumes of non-performing loans, banks have in recent quarters tended to reduce, rather than increase, their overall provisions against future losses. In the 12 months to the end of March 2016, loan-loss provisions totalled Tk266 billion, a shortfall of Tk42.8 billion, according the central bank’s Regulation and Policy Department, and a decline of Tk14.6 billion against the previous year.
Meanwhile, the provision maintenance ratio slipped to 88.2% at the end of September 2016, against 97.3% at the start of 2015 – yet another metric that appears to be heading in the wrong direction. At the end of September 2016, the ratio of non-provisioned and non-performing loans stood at 11.5% of all outstanding lending.
Nor are failed loans and low provisioning rates and ratios the only concern for Bangladesh’s legion of lenders. Data contained in the central bank’s latest FSA report suggest that the very roots of the banking sector are rotting. Aggregate return on equity at the nation’s 56 lenders fell to 6% at the end of September 2016, against 12.2% two years earlier, with aggregate return on assets declining from 2.2% to 0.9%. The industry’s overall capital adequacy ratio inched down a little over the same period, to 10.5% from 10.6%.
On the positive side of the ledger, industry-wide earnings have ticked up a little, with pre-tax profit rising 9% year on year in the 12 months to the end of March 2016, on a 4.2% gain in net interest income. But even here there are mitigating factors at work.
Analysts believe much of this improvement is due to a supportive macro environment, including a strong economy (annualized GDP growth of 7.1% in the full year 2016), relatively benign inflation (currently in the mid-single-digits) and rising foreign currency reserves (up 19% year on year to $31.4 billion over the 12 months to the end of September 2016).
“Bangladesh’s economy is in a very sweet spot right now,” notes Exotix Partners’ Khan. “We are benefiting from low oil and commodity prices, and sweet demographic dividends.”
One of the largely unreported side effects of a financial industry bogged down by too many stagnant lenders is that they continually need bailing out. This happens every year and very quietly, when the government carves out a generous slice of its budget to recapitalize banks riddled with so many bad loans, their equity is all but worthless. In its 2015/16 budget, the state set aside Tk500 billion for this very reason.
“The worst banks get a nice chunk of change each year, then retreat to make more bad loans,” sighs one senior figure in the banking sector.
Making ends meet
Under-pressure institutions are also coming up with new ways to make ends meet: in March, three state lenders were given approval to raise up to $510 million to improve their financial health. Basic Bank, which had, at the end of 2016, a staggering NPL ratio of 54%, as well as a capital shortfall of $335 million, will print $325 million worth of government-guaranteed cashless bonds – a mixture of 10-, 15- and 20-year notes – marking the first time the debt instrument has been used onshore. Janata Bank and Rupali Bank will sell smaller tranches of subordinated paper.
Is there anything or anyone who could force through change? Events, economic rather than political, and stemming from external factors far from the country’s shores, may do the trick. At present the sovereign, with its strong state finances and growth figures, has no need for capital from multilaterals like the World Bank, and even less interest in unsolicited financial advice.
“If the country needs cash, it can turn to India, China or Japan. So there is little or no real impetus for financial-sector reforms,” says Exotix Partners’ Khan.
Rising commodity or energy costs may move the meter, particularly if the per-barrel dollar price of oil ticks up again into the high double-digits. “If government finances are squeezed, it will be harder for them to justify putting aside tens of billions of dollars each year just to bail out the banking sector,” says a south Asia expert at a leading multilateral.
Interest rates may rise sharply – always a possibility – forcing banks to cast around for capital, leaving government to determine whether to extend financial support to its army of lenders or let some go to the wall.
Bangladesh is also moving toward implementing Basel III rules. By 2019, banks will need to hike their capital adequacy ratio up to and preferably beyond 12.5%, and with the aggregate sector-wide CAR currently 200 basis points below that level, many lenders will, within the next 24 months, find themselves undercapitalized. Will the central bank use that event horizon as an excuse to push through much-needed change – or will it watch the pitch go by?
The next few years will be key to the country’s long-term future, and banks, given the lack of deep and liquid onshore capital markets, should play a big role in shaping that change.
Abrar Anwar, country head and CEO of Standard Chartered Bangladesh, the biggest foreign player, talks of his “excitement” of being at the heart of such a fast-growing frontier state. Special economic zones are springing up around the country; technology clusters are forming; political unrest is largely under control; and economic output is expanding nicely.
The only regret is the lack of oversight and good governance at a majority of lenders. Too many remain dependent on the state for capital and direction, while too few are driven by the basic principles of good governance and due diligence.
In the long-term, the best way to solve the country’s banking problems – too many lenders making poorly scrutinised loans to delinquent borrowers – is to clear a lot of the dead wood out of the system.
|Sohail Hussain, City Bank|
Adds Exotix Partners’ Khan: “It fragments the sector when you have too many competing institutions, and it hurts profitability. And too many of our banks don’t offer differentiated products. The majority are very same.”
It’s clear what Bangladesh needs: a better banking sector festooned with fewer lenders; a more independent-minded central bank willing not just to gnash its teeth and shake its fist, but shake the entire banking sector up, closing down lenders or forcibly merging them; regulators able to stand up to politicians; and politicians willing to stare down their delinquent friends at the helm of the nation’s biggest corporates.
And if Bangladesh needs a handy guidebook, it need look no further than its big sovereign neighbour, India, where a banking sector once clogged with bad debts is being overhauled, and where influential voices in New Delhi are forming plans to whittle down the number of state lenders from too many, to a precious and well-run few.
Dhaka could go down that path too. It just needs to want to.