Forced bank mergers are likely to be counterproductive without a thorough assessment of asset quality, said the World Bank in its latest report on Bangladesh on Tuesday.
Rapidly implementing bank mergers before addressing these issues may further undermine confidence in the sector, deterring intermediation capacity, according to a report titled "Bangladesh Development Update, Special Focus: Strengthening Domestic Resource Mobilization," released by World Bank.
In March 2024, Bangladesh Bank announced plans to merge weak banks with strong banks, Exim Bank and Padma Bank signed a letter of intent to merge, initiating the first merger process.
The World Bank emphasized the need for a thorough evaluation of asset quality of banks before mergers. Rushing into mergers without addressing these concerns could erode investor confidence in the financial sector, according to their report.
The report said that while bank mergers are a viable tool for consolidating the banking sector, they should be part of a broader strategy that includes resolution tools and guidelines for mergers and acquisitions.
The report further stated that resolution tools are needed and that bank mergers are only one of the tools that could support the consolidation of banks in Bangladesh. Moving forward with mergers, as opposed to the full menu of options, would still require a thorough assessment of asset quality in weak banks to protect the good banks.
The World Bank stressed the importance of developing comprehensive guidelines before proceeding with forced mergers to ensure the protection of strong banks. They expressed readiness to assist the government in building a stronger banking sector.
At the press briefing, it was also stated that a consolidation process will require careful assessment and prudent implementation of procedures to avoid weakening good banks and acquiring bad banks. An assessment of the asset quality of weak banks will be required.
The Bangladesh Bank's announcement in March 2024 regarding plans to merge weak banks with strong ones, with Exim Bank and Padma Bank initiating the first merger, has drawn attention. However, concerns persist regarding the assessment of asset quality and the potential impact on the stability of the banking system.
The World Bank's observation follows shortly after Exim Bank, operating under Shariah principles, agreed to take over the struggling Padma Bank.
Highlighting the prevalence of Non-Performing Loans (NPLs) and undercapitalized banks, the World Bank emphasized the necessity for additional tools to address vulnerabilities.
These tools include strengthening corporate governance and implementing modern resolution tools for insolvent banks, along with enhancing deposit insurance schemes.
Before commencing any merger processes, the World Bank stressed the importance of issuing detailed guidelines on mergers and acquisitions.
These guidelines should offer banks a clear understanding of the procedures involved, drawing upon international best practices.
Moreover, they should provide various merger mechanisms for banks to choose from, depending on their specific circumstances.
Bank mergers will also require an evaluation of internal systems, branch networks, staffing levels, adequacy of management arrangements, impacts on banks' cross-border business, and international risk ratings.
WB Country Director for Bangladesh and Bhutan Abdoulaye Seck, its Chief Economist for South Asia Region Franziska Ohnsorge, and its Senior Economists Bernard James Haven and Rangeet Ghosh also spoke at the press briefing.
Crawling peg needs to rebuild reserve
The World Bank highlighted the complexity of Bangladesh's exchange rate regime. It noted that multiple exchange rates were introduced in September 2022, which had negative effects such as discouraging foreign currency inflows and causing market uncertainty. While some of these exchange rates have been consolidated, there are still different rates for interbank transactions and remittance inflows.
The lack of transparency and liquidity in the foreign exchange market is impacting the balance of payments. The World Bank suggested that adopting a crawling peg mechanism could help establish a market-clearing exchange rate, narrowing the gap between formal and informal exchange rates.
This, in turn, could attract more remittances through formal channels, making informal channels less appealing. It could also reduce the financial account deficit by expanding trade credit and other external financing options.
Currently, the official exchange rate stands at Tk110 per dollar, while the unofficial rate is higher, ranging from Tk115 to Tk120.
From January to June 2024, the Bangladesh Bank (BB)'s Monetary Policy Statements (MPS) indicated it is considering adopting a crawling peg system.
However, the timeline for implementation and a technical methodology have not been announced, said the report.
The World Bank report suggested that exchange rate reforms are urgently needed to rebuild the external buffers.
The reform would also help ensure sufficient foreign exchange liquidity, essential for fulfilling debt service and other external payment commitments.
According to the report, significant downside risks to the outlook stem from delayed implementation of external and financial sector reforms. Delays in exchange rate reforms can result in the continued depletion of international reserves to critically low levels.
From January to June 2024, the Bangladesh Bank (BB)'s running Monetary Policy Statements (MPS) indicated it is considering adopting a crawling peg system.
However, the timeline for implementation and a technical methodology have not been announced, said the report.