In this third article on Bangladesh Bank we take up the very sensitive matter of Bangladesh Bank’s role in supervision of the commercial banks.
I use “bank supervision” as more or less “on site supervision”; this involves the visit to the commercial bank’s head office and some branches of a team from the central bank to inspect the records.
The focus is on private banks.
Supervision in 2022 has I suggest five major tasks:
· To review the commercial bank’s identification of non-performing loans
· To check if the interest component of such loans is correctly entered into the accounts
· To check that the required provisions have been entered into the balance sheet
· Loan write-offs are correctly handled
· Loan rescheduling meets the rules established by the central bank.
In my view all loans with balance outstanding above Tk50 crore should be scrutinized, including the financial statement of the borrower.
All loans to companies listed on the stock markets should also be reviewed.
Also Read - Bangladesh Bank needs to be free from influence
Also Read - Why it’s important Bangladesh Bank remains independent
All major loan reschedulings for loans with balance outstanding above Tk20 crore should be reviewed.
Such systematic review of large loans is not so common but is an important matter.
In Bangladesh experience indicates that it is large borrowers who are the more delinquent than the small in repaying.
Forcing the commercial banks to account for loan losses has been the most important step in building a strong banking system.
Maintaining the quality of this procedure implemented though on site supervision will be a growing challenge and should be one of the priority areas for the governor’s attention.
The problem of the high level of non-performing loans (NPLs) is the most important problem in the Bangladesh financial sector.
The first task of bank inspection is to verify that the accounting follows Bangladesh Bank’s rules so the inspection process must give assurance that the reporting on NPLs is correct.
For large loans and loans to listed companies there should be an analysis of the borrower’s financial performance over the past three years and a conclusion reached as to whether this loan will be fully repaid based on the actual performance of the company.
The risk weighting analysis should be included in this review.
For this set of loans the inspection should assess the quality of the risk weighting analysis and summarize the reliability of the process.
Large rescheduling actions should be reviewed to determine if the bank has any analysis to show the loan can be repaid after rescheduling.
The calculation of risk weighting to determine capital adequacy is reviewed to insure the calculations are as the central bank requires.
The inspector must come to a position on whether the bank has maintained the required capital.
Further reviews
To review the management of the foreign exchange accounts and ensure proper implementation of the foreign exchange control rules, the correct use of the Swift system by the commercial bank must be verified.
In particular large imports must be checked to insure an actual import transaction took place.
In recent years there has been large scale money laundering based on paying for imaginary imports.
Bangladesh Bank should consider establishment of a section to verify prices for large import orders on goods with low customs duties to limit the all too common over invoicing of such items.
Equally, Bangladesh Bank can do far more to check with the Indian, Japan and Chinese central banks to limit under invoicing of imports from these countries.
This is a difficult task; ideally there would be cooperation with customs, but such a development is very unlikely.
The failure to control under invoicing and over invoicing is one of Bangladesh Bank’s most unsatisfactory performances.
This opens the door to widespread money laundering and tax avoidance.
Examine and test security of computer systems in use within a commercial bank
The IT systems must correctly maintain the accounts of the bank and provide security against manipulation of the accounts by the bank staff.
But perhaps more important, is the security of the IT systems against external hackers, illegal entry of outsiders into the systems and the manipulation of accounts to steal funds from the bank.
A much greater inspection effort is needed.
To come to an overview of the bank as a financial institution
The main objective of the supervision process is to ascertain that the risks to the depositors' funds are low and within the limits established by the central bank.
The first part represented is that the account aggregating all of the operations, assets, and liabilities of the bank are correct.
Then the supervisors review the relationships between the different accounts to identify areas where there is risk that the bank will be unable to return the depositors money on request.
Further that if the bank loses money during its operations that these losses will be covered by the capital of the bank, i.e. the funds provided by the owners of the bank.
The greatest weakness here is the integrity of the capital adequacy calculations.
A few banks should be subjected to an external audit of their capital adequacy estimates.
The directors should be interviewed with the inspector having a full account of all loans taken by the director, all loans to companies the director owns 10% or more and loans to listed companies where the director has more than 10% of the shares.
Directors should sign that this report is a complete record of loans associated with his financial holdings.
The inspection should review if any company in which a director has a substantial interest is obtaining loans from the bank being inspected.
This is an area where Bangladesh Bank is seriously behind what is needed.
An experienced bank supervisor will develop a feel for the vulnerability of the bank to various threats.
He will often test this by stress tests to determine what might happen to a bank if some significant changes took place, (e.g. 5% of deposits are withdrawn).
This type of analysis is done by off site inspection and supplements the on-site inspection.
In this final stage of the supervision process the inspector comes to an overall assessment of the strength of the bank.
In carrying out his work the inspector assesses key aspects of the bank (This is the Camel rating system.)
· C - Does it have enough capital so that it can survive external events that may cause it to lose money?
· A - What is the quality of its assets? Is there a lot of risk in the loans that have been made?
· M - Is the bank well managed?
Again, the inspector’s overall judgment based on the observed actions of the bank’s managers provides an estimate of the management quality.
This is more likely to be judgmental than quantitative.
· E - Has the bank made a profit?
Well run banks must make a reasonable level of profits both to build up additional capital and to provide dividends for the owners.
· L - Does the bank have sufficient liquidity to meet the depositor’s withdrawals?
This largely rests on the amount of government securities that the bank owns.
Issues
This inspection work is done reasonably well by Bangladesh Bank.
The first area of concern is the security of the IT systems.
This should be an important part of the inspection process and deserves much more care than it now receives.
The second weakness is insufficient attention is devoted to review of large loans, projecting capacity to repay against the evolution of the borrower’s earnings and costs.
The commercial bank’s loan officer should be able to do this and explain to the central bank inspector the analysis.
This review should also cover large rescheduled loans and all listed companies.
A third area where improvement is needed is the training of on-site bank inspectors.
Much more is needed: The inspector should work in a commercial bank for at least six months to gain experience in how a bank actually operates.
Handbooks should be revised regularly and training on new procedures provided.
Work related training at all levels of the inspection process is essential.
There can never be too much training.
Ideally certifications should be available for different experience levels and activities; then training provided and certification exams can be conducted.
The fourth area is corruption.
Over the past few years there have been distressing rumors and reports of corruption of the inspection process where Bangladesh Bank officials took money to allow scams to pass scrutiny or allowed bank loan rescheduling that should not have taken place.
This internal corruption has not received the attention that I believe it should. Inspectors in all supervision systems will be tempted by opportunities that appear.
One finds such behavior at the Federal Reserve.
What is important is not to deny and play ostrich; but to establish safeguards and audits to discourage such temptations.
Corrupt behavior must be punished.
The public wants the banks to be safe to ensure that their deposits are safe.
It is Bangladesh Bank’s inspection system that must convince the public of the integrity of the banks.
There is always room for improvement but after watching for almost thirty years I think that Bangladesh Bank does an excellent job and the public can be confident of the soundness of the banking system.
However, improvements are needed at the four points mentioned: Inspection of computer systems; increased attention to large loans; greater training; finally an improved anti-corruption unit at Bangladesh Bank.
Forrest Cookson is an economist who has served as the first president of AmCham and has been a consultant for the Bangladesh Bureau of Statistics
