The Overview of Banking Activities in Bangladesh

Introduction This chapter provides an overview of the banking activities in Bangladesh, developments & performance of the banking sector. Bangladesh has a mixed banking system comprising nationalized, private and foreign commercial banks. Bangladesh Bank (BB) has been working as the central bank since the countrys independence. Its primejobs include issuing of currency, maintaining foreign exchange reserve and providing transaction facilities of all public monetary matters. BB is also responsible for planning the governments monetary policy and implementing it thereby. Banking History of Bangladesh The banking system at independence consisted of two branch offices of the former State Bank of Pakistan and seventeen large commercial banks, two of which were controlled by Bangladeshi interests and three by foreigners other than West Pakistanis. There were fourteen smaller commercial banks. Virtually all banking services were concentrated in urban areas. The newly independent government immediately designated the Dhaka branch of the State Bank of Pakistan as the Central Bank and renamed it the Bangladesh Bank. The bank was responsible for regulating currency, controlling credit and monetary policy, and administering exchange control and the official foreign exchange reserves. The Bangladesh Government initially nationalized the entire domestic banking system and proceeded to reorganize and rename the various banks. Foreign-owned banks were permitted to continue doing business in Bangladesh. The Insurance business was also nationalized and became a source of potential investment funds. Cooperative credit systems and postal savings offices handled service to small individual and rural accounts. The new banking system succeeded in establishing reasonably efficient producers for managing credit and foreign exchange. The primary function of the credit system throughout the 1970s was to finance trade and the public sector, which together absorbed 75 percent of total advances. The governments encouragement during the late 1970s and early 1980s of agricultural development and private industry brought changes in lending strategies. Managed by Bangladesh Krishi Bank, a specialized agricultural banking institution, lending to farmers and fishermen dramatically expanded. The number of rural bank branches doubled between 1977 and 1985, to more than 3,330. Denationalization and private industrial growth led the Bangladesh Bank and the World Bank to focus their lending on the emerging private manufacturing sector. Scheduled bank advances to private agriculture, as a percentage of sects oral GDP, rose from 2 percent in FY 1979 to 11 percent in FY 1987, while advances to private manufacturing rose from 13 percent to 53 percent. The transformation of finance priorities has brought with it problems in administration. No sound project-appraisal system was in place to identify viable borrowers and projects. Lending institutions did not have adequate autonomy to choose borrowers and projects and were often instructed by the political authorities. In addition, the incentive system for the

banks stressed disbursements rather than recoveries, and the accounting and debt collection systems were inadequate to deal with the problems of loan recovery. It became more common for borrowers to default on loans than to repay them, the lending system was simply disbursing grant assistance to private individuals who qualified for loans more for political than for economic reasons. The rate of recovery on agricultural loans was only 27 percent in FY 1986, and the rate on industrial loans was even worse. As a result of this poor showing, major donors applied pressure to induce the government and banks to take firmer action to strengthen internal bank management and credit discipline. As a consequence, recovery rates began to improve in 1987. The National Commission on Money, Credit, and Banking recommended broad structural changes in Bangladeshs system of financial intermediation early in 1987, many of which were built into a three-year compensatory financing facility signed by Bangladesh with the IMF in February 1987. One major exception to the management problems of Bangladeshi banks was the Grameen Bank, begun as a government project in 1976 and established in 1983 as an independent bank. In the late 1980s, the bank continued to provide financial resources to the poor on reasonable terms and to generate productive self-employment without external assistance. Its customers were landless persons who took small loans for all types of economic activities, including housing. About 70 percent of the borrowers were women, who were otherwise not much represented in institutional finance. Collective rural enterprises also could borrow from the Grameen Bank for investments in tube well, rice and oil mills, and power looms and for leasing land for joint cultivation. The average loan by the Grameen Bank in the mid1980s was around Tk 2,000(US$65), and the maximum was just Tk 18,000 (for construction of tin-roof house). Repayment terms were 4 percent for rural housing and 805 percent for normal lending operations. The Grameen Bank extended collateral-free loans to 200,000 landless people in its first 10 years. Most of its customers had never dealt with formal lending institutions before. The most remarkable accomplishment was the phenomenal recovery rate; amid the prevailing pattern of bad debts throughout the Bangladeshi banking system, only 4 percent of Grameen Bank loans were overdue. The bank had from the outset applied a specialized system of intensive credit supervision that set it apart from others. Its success, though still on a rather small scale, provided hope that it could continue to grow and that it could be replicated of adapted to other development-related priorities. The Grameen Bank was expanding rapidly, planning to have 500 branches throughout the country by the late 1980s. Beginning in late 1985, the government pursued a tight monetary policy aimed at limiting the growth of domestic private credit and government borrowing from the banking system. The policy was largely successful in reducing the growth of the money supply and total domestic credit. Net credit to the government actually declined in FY 1986. The problem of credit recovery remained a threat to monetary stability, responsible for serious resource misallocation and harsh inequities. Although the government had begun effective measures to improve financial discipline, the draconian contraction of credit availability contained the risk of inadvertently discouraging new economic activity. Foreign exchange reserves at the end of FY 1986 were US$476 million, equivalent to slightly more than 2 months worth of imports. This represented a 20-percent increase of reserves over the previous

year, largely the result of higher remittances by Bangladeshi workers abroad. The country also reduced imports by about 10 percent to US$2.4 billion. Because of Bangladeshs status as a least developed country receiving concession loans, private creditors accounted for only about 6 percent of outstanding public debt. The external public debt was US$6.4 billion, and annual debt service payments were US$467 million at the end of FY 1986. Banking sector of Bangladesh The banking sector in Bangladesh comprises of four types of scheduled banks, namely, stateowned commercial banks (SCBs), government owned development finance institutions (DFIs), private commercial banks (PCBs) and foreign commercial banks (FCBs). At present there are four state-owned commercial banks (SCBs) operating in Bangladesh. The second typedevelopment finance institutions that derive their funds mainly from the government, other financial institutions and supranational organizations. Development banks have taken a variety of specific forms, but most of them are oriented toward specific economic activity or toward a region. There are five development finance institutions (DFIs) in Bangladesh. The third category, i.e. private banks financed the development of the currently industrialized countries. Frequently they were instrumental in identifying investment possibilities: arranging for the importation of skilled managers, workers and raw materials; and taking initial steps toward assuring markets for output. None of this was done, needless to say, for eleemosynary purposes. The profit motive stimulated lending to enterprises to promising sectors. In this category there are thirty local private commercial banks (PCBs) and nine foreign Commercial Banks.

Bank Types SCBs DFIs PCBs FCBs Total

No. of Banks

No. of Branches

4 3404 4 1382 30 2810 09 62 47 7658 Source: Bangladesh Bank database

Performance of the banking sector The banking sector in Bangladesh has come under criticism in the recent past due to increased number of financial scams and the rising size of loan default. Undoubtedly, the size of the industry has expanded in terms of total banks and their branches, deposits and credits which in turn have contributed to the economic development of the country. The performance of the banking sector has also improved over the years according to various indications such as capital to risk weighted asset, rate of non-performing loan (NPL) to total loan, expenditure income ratio, return on asset, return on equity, and liquidity. This has been possible due to various reform

measures and policy support of the consecutive governments. Unfortunately, the health check fails to conceal the problems suffered by the sector from time to time. The current situation of the large financial frauds and high NPL of banks call for a close scrutiny of the sector and necessitates taking required measures. The first reading of the IRBD of CPD prepared in January 2013 presented a detailed analysis of the trend and the governance of the banking sector in the context of the Hallmark scam (CPD 2013). This section will focus on a selected set of issues relating to some of the emerging concerns. Framework for analysis The major data sources for this study are Bangladesh Bank Annual report. In this regard banks are categorized broadly into four categories: State-owned Commercial Banks (SCBs), Government owned Development Finance Institutions (DFIs), Private Commercial Banks (PCBs) and Foreign Commercial Banks (FCBs). The time period covered in basically from 2010 to 2011. Assets and Diposits of Banking Sector in Bangladesh

Banking Performance of Bangladesh The banking performance of Bangladesh comprises four categories of scheduled banks. These are the State-owned Commercial Banks (SCBs), Government owned Development Finance Institutions (DFIs), Private Commercial Banks (PCBs) and Foreign Commercial Banks (FCBs). While the number of banks remained unchanged at 47 in 2011 the number of bank branches increased from 7658 in 2010 to 7961 in 2011 reflecting the opening of new branches by the PCBs. At the end of june 2012, the total number of bank branches increased further to 8059, with total number of banks remaining unchanged at 47. The structure of the banking sector with breakdown by type of banks in shown in charts.

Aggregate Industry Assets (Dec 2011) (Billion Taka)

1.00% 14.10% 64.60% 6.80% Loans & Advances - 3792.5 Other Assets - 822.6 Cash n tills - 59.7 Deposits with BB - 399.5 Govt Bills & Bonds - 793.4

Aggregate industry liabilities (Dec, 2011) (Billion Taka)

9.10% 14.00% Deposits - 4509.7 76.90% Other Liability - 821.9 Capital & Reserve - 536.0

Capital Adequacy Capital adequacy focuses on the total position of banks capital and the protection of depositors and other creditors from the potential shocks of losses that a bank might incur. It helps absorbing all possible financial risks like credit risk, market risk, liquidity risk; reputation risk, settlement risk, strategic risk, environmental & climate change risk etc. Under Basel- II, banks in Bangladesh were instructed to maintain the minimum capital requirement (MCR) at 10.0 percent of the Risk Weighted Assets (RWA) or taka 4.0 billion as capital, whichever is higher, with effect from July- September quarter in 2011. MCR was revised to increase the shock resilient capacity of the bank. However, for the fourth quarter of 2011 MCR was lowered to 9.0 percent of RWA or taka 2.0 billion, whichever is higher.