Banking Sector Reforms in Bangladesh and Its Impact. Examination Committee Dr. Juthathip Jongwanich Dr. Sundar Venkatesh Dr.

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1 Banking Sector Reforms in Bangladesh and Its Impact Muhammad Mustafizur Rahman Examination Committee Dr. Juthathip Jongwanich Dr. Sundar Venkatesh Dr. Sununta Siengthai

2 Agenda of the Presentation o Objectives of the Study o Research Methodology o Background of the Reforms o Banking Sector Reforms in Bangladesh o Impacts of Reforms on Financial Development Performance of Banking Sector o Conclusions and Policy Inferences

3 Objectives o Review the banking sector reform programs; o Assess the development of the financial system; o Compare the financial performance of the banking system; and o Suggest some policy measures for strengthening the restructuring mechanism.

4 Research Methodology o Banking sector is divided into four groups o Main sources of data are secondary o Data collected from different sources are compared with those of BB departmental database o Development in the financial system is assessed by time series data since o Trend analysis of time series data since 1997 is done to indicate the banks' performance. o Banks' performance is assessed using the components of CAMEL framework.

5 o Aim to achieve economic objectives of govt. o Rigid government control o Fixed interest rates o Directed credits o Directed expansion of branches Background of Reform 1972 to 1982 o Branches increased o Population per branch reduced o Poor credit analysis o Lending rates were low o Poor debt recovery o Profitability declined o Operational efficiency deteriorated

6 o Two NCBs denationalized Background of Reform o PCBs allowed to operate o Excessive government interference o Regulations based on economic consideration o Absence of prudential regulation o Inadequate legal support for debt recovery 1983 to 1989 o Customer service improved o Undue influence of the vested interest groups o Profitability of the industry declined o The four NCBs were technically insolvent

7 Instigation of Reforms National Commission on Money, Banking and Credit was formed in 1986 in order o to identify the major problems, and o to suggest remedial measures for the efficient management of the banking system

8 Reforms Programs Objectives Financial Sector Reform Program o To remove distortions and bring competitiveness in the financial sector, o To make NCBs commercially viable for subsequent privatization, and o To help PCBs to increase their market share in total commercial banking. Commercial Bank Restructuring Project To identify the urgent course of actions Objectives needed for continuing the development of commercial banks.

9 Policy Reforms Major Reform initiatives o o o o o Risk-Based Capital adequacy Loan Classification and Provisioning Credit Risk Grading Interest Rate Deregulation Performance Planning System Institutional Reforms o o o Off-site Supervision Credit Information Bureau Large Loan Reporting System Legal Reforms o The Banking Companies Act, 1991 o Artha Rin Adalat Act, 1990 o Bankruptcy Act, 1997

10 Impact of Reforms Financial Sector Development o Financial Deepening Size and Depth Mobilization of savings Improvement in the cash flows towards the banking system o Competitiveness within the industry o Profitability of the banking industry

11 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% Impact of Reforms on Financial Sector Size and Depth M 2 /GDP Ratio 42.0% 37.0% 32.0% % 22.0% 17.0% 12.0% Private Credit/GDP Ratio

12 Impact of Reforms on Financial Sector Mobilizing Savings 32.0% 30.0% M 1 /M 2 Ratio 28.0% 26.0% 24.0% 22.0% 1992 y = x y = x Cash flows to Banking System 87.0% 86.0% 85.0% 84.0% 83.0% 82.0% 81.0% 80.0% 79.0% 78.0% M 2 /M 3 Ratio y = x y = x 2012

13 Impact of Reforms on Financial Sector Competitiveness of the Banking Industry 60.00% Concentration ratio within the total deposits 40.00% 20.00% 0.00% Top Bank Top 5 Banks Top 10 Banks Herfindahl-Hirschman Index Deposits Loans

14 Impact of Reforms on Financial Sector Profitability of the Banking Industry Return on Assets Y = X Y = X Return on Equity Y = X Y = X Taka in Billions Net Interest Income Y = X Y = X

15 Impact of Reforms on Bank Performance Measures of Performance o Capital Adequacy o Asset Quality o Management Efficiency o Earning Performances o Liquidity

16 Impact of Reforms on Bank Performance Capital Adequacy: Capital to Risk Weighted Assets Ratio Percent Financial Year SCBs DFIs PCBs FCBs

17 Impact of Reforms on Bank Performance Capital Adequacy: FCBs and PCBs Percent Financial Year PCBs FCBs

18 Impact of Reforms on Bank Performance Asset Quality: Non-Performing Loans to Total Loans Ratio Percent Financial Year SCBs DFIs PCBs FCBs

19 Impact of Reforms on Bank Performance Management Efficiency: Expenditure-Income Ratio Percent Financial Year SCBs DFIs PCBs FCBs

20 Impact of Reforms on Bank Performance Management Efficiency: FCBs and PCBs Percent Financial Year PCBs FCBs

21 Impact of Reforms on Bank Performance Earning Performances: ROA, ROE and NII Return on Assets Return on Equity Percent Percent Financial Year Financial Year SCBs DFIs PCBs FCBs SCBs DFIs PCBs FCBs Net Interest Income Taka in billions Financial Year SCBs DFIs PCBs FCBs

22 Impact of Reforms on Bank Performance Earning Performances: FCBs and PCBs Return on Assets Return on Equity Percent Percent Financial Year Financial Year PCBs FCBs PCBs FCBs Net Interest Income Taka in billions Financial Year PCBs FCBs

23 Impact of Reforms on Bank Performance Liquidity: Liquid Assets/Deposits Liquid Assets/Deposit Percent Financial Year SCBs DFIs PCBs FCBs Excess Liquidity/Deposit Percent Financial Year SCBs DFIs PCBs FCBs

24 Conclusion o Following restructuring initiatives, financial system has been developed in terms of Financial deepening, Competitiveness within the industry, and Profitability scenario of the banking industry. o Defaulted loans can be identified easily and monitored continuously for recovery and necessary provision can be made; o Classified loans, provision shortfall and loan losses are now more transparent;

25 Conclusion o An improvement and better performance of capital adequacy of banks helped to restore the interest of the depositors and shareholders; o Management performance in monetary terms is on increasing trend; o In terms of profitability the banking sector had mixed experience; o All types of banks have much liquid assets excess of their requirements.

26 Conclusion o The performances of the foreign banks are better in comparison to the local banks in some aspect. FCBs could be able to maintain a CRAR which is higher than that maintained by the domestic banks. Non-performing assets of FCBs are negligible comparing with their assets. Though FCBs maintained a substantial amount of liquidity, their profitability is higher than the domestic banks. FCBs were capable to control their expenditureincome ratio lower than the domestic banks.

27 Conclusion o FCBs are performing much better than the domestic banks perhaps due to following reasons: FCBs have to comply additionally with the policies and guidelines issued by their head office, They are exploiting the international best practices in their operation, They are audited by their head offices regularly which help them to have more controlling systems, They get support from their head office in analyzing risks including credit risks and operational risks, They can easily track the recovery of loans as they have limited branches and customers, and advanced MIS and AIS.

28 Recommendations 1. Solvency: The undercapitalized banks should be allowed/motivated to raise new capital from the capital market. 2. Management of NPL : All bad or non-performing loans of banks can be put under separate management within the same institution. 3. Auditing: An international standard based audit of the loan portfolio, assets and liabilities, and capital adequacy may be performed. 4. Road-map: Banks with problems and weakness may be asked to submit a plan of corrective actions along-with a time schedule to overcome the problems.

29 Recommendations 5. Strengthen legal enforcement: Special tribunals having simplified procedures, quick disposal, and effective enforcement have to be ensured. 6. Reduction of Interference: Government interference, political involvement, pressure from the trade unions, connected lending have to be reduced for smooth functioning of the banks. 7. Technological Advancement: Technological upgradation of the banking system is must for a better and an efficient banking sector in Bangladesh. 8. Extensive Training: Large scale training program for both central bank and commercial bank officials should be arranged to achieve effective outcome from the reforms.

30 Thanks