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Dhaka Tribune

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Summing up four pertinent issues

Update : 09 Dec 2021, 08:38 PM

This is a time to pause and review.

This article examines four important issues in the Bangladesh financial sector.

Four areas are reviewed: Managing the exchange rate; regulation of interest rates for deposits and loans; the problem of non-performing loans; and cyber security of the banking system. 

These four areas are the most serious issues confronting the financial system at the end of 2021.

Three deal with the banking sector which is by far the dominant means of mobilizing savings and directing these to enterprises; hopefully to the highest return projects.

In all four cases these challenges are not new rather the potential dangers are increasing.

1.  Managing the exchange rate

The exchange rate is fixed by Bangladesh Bank on a daily basis, instructing banks the Taka/dollar rate. 

The basic objective of Bangladesh Bank is to keep the Taka/dollar rate stable.

The authorities believe that the exchange rate has a strong impact on prices.

Maintaining a low inflation rate (5-6% per annum) is an important objective of monetary policy.

But there is widespread belief that the inflation rate is very sensitive to the exchange rate.

However, the data do not give strong confirmation of this belief.

The Taka has depreciated with respect to the dollar about 2% per annum over the past decade.

The inflation rate has averaged about 6% per year.

Bangladesh Bank supports the exchange rate by buying dollars when the currency is strong and selling dollars to prevent the market forcing depreciation.

The large increase in reserves in the past two years reflects that action.

The result of this policy is to reduce competitiveness of exports.

The Real Effective Exchange Rate which captures the competitiveness with trading partners has appreciated significantly; the Taka becomes more valuable so products made in Bangladesh are more expensive.

The consequences are twofold:

(1)        The manufacturers of RMG are under great pressure from rising costs and falling selling prices. 

(2)        There has been very limited success in diversification of exports. No export category has grown steadily and exceeded $1 billion/year. 

The ratio of exports to GDP has been declining, reducing the export-led driving force.

At present, export led growth is not really successful.

Of course, this is a very difficult problem: In an era of rising world inflation, depreciation of the Taka is a doubtful strategy.

However, a strategy of allowing depreciation according to the market plus tougher monetary policy, might achieve a shift to greater export profitability with limited increase in the inflation rate.

Accepting that this is a difficult environment to raise export profitability, the point remains it is really necessary to allow the Taka to follow the market and cease central bank interventions.

The central bank’s job is to reduce inflation.

2.  Interest Rates

Current rules for interest rates are:

(1)        Fixed deposits: Rate is equal to or greater than the recent inflation rate (12 month average usually lagged two months).

(2)        Loans and advances 9%.

(3)        Spread between highest risk loan and lowest risk loan 3%.

(4)        Floor rate on fixed deposits is negative real rate taking account of taxes.

(5)        Ceiling on lending rate is negative if 25% company tax.

(6)        Estimated no risk rate June 2021 7.5% (no risk).

Observations:

 1.  The prime rate (cost of lending w/o risk) is close to lending rate cap (9%).

2.  Spread of loan cost is now 6-9%, or more realistically (7.5-9%).

3.  Results in transfer of wealth from low risk borrowers to high risk borrowers.

4.  Rising inflation with a lending rate cap, will reduce the spread and bank profits. Interest rate rules undermine good banking and encourage corrupt banking practices.

5.  Average quality of loans will worsen.

6.  There are two conditions that may emerge in the loan market. The desirable case is where the private sector has applied for many loans. Then the banks sort out which are likely to repay both from the nature of the loan and the character of the borrower.

The second condition arises when the lending rate is controlled so there are many more loans that appear acceptable than available savings to finance these.

The banks are then forced to ration loans by criteria other than the expected return on the loan.

This condition holds in Bangladesh today with a negative interest rate for borrowers as all projects are viable.

Loans are given without much concern for the quality of the projects being supported.

All of these matters clear up by removing the cap on lending rates.

3.  Non-performing loans:

Ever since Bangladesh became a nation the financial system has been troubled with poor loan recovery rates.

Tough provisioning rules and implementation are needed to make the banks pay attention to low quality.

Support from the judicial system is needed to enforce the lending contract.

Systematic procedures for rescheduling and restructuring are needed to cover the many cases where repayment is due to factors external to the borrower.

These are the three actions needed to improve the repayment of loans.

The first requires the central bank to supervise the assessment of the loan repayment record [but the decision to make the loan rests with the bank] and ensure that the requisite determination of loan quality is made and provisions are taken.

This is a big effort for the central bank.

The initial step is to take the 5,000 largest loans made to the private sector and track the progress every month.

Using modern IT methods this is not a very difficult job. 

There are Artificial Intelligence programs available that will indicate the probability of a loan being repaid; 200 central bank staff, each responsible for 25 large loans, is a feasible level of manpower.

The improvement of judicial support is best accomplished by expanding the number of money loan courts and increasing the training of judges handling these cases.

The performance record of the money loan courts should be tracked regularly.

A panel of senior judges should make a semi-annual report on progress and make recommendations to the Chief Justice about improvements in procedures etc.

Implementation is the responsibility of the judicial system but the goals and objectives are set by legislation.

The light of regular publicity on these courts will enhance repayment.

It is a common belief that loans are not repaid as the borrower simply refuses to do so and ultimately, he gets away with it.

But that is a very simplistic version of the world.  I believe most borrowers genuinely want to be successful in their projects.

The real world is complicated and many things go wrong.  For example, the government may be slow to approve an application or to deal with land acquisition issues.

The delays lead to the buildup of large interest amounts due and makes the financial success of the project.

A perfectly good project can be ruined by a delay of two years at startup.

The borrower and the bank should be able to solve such problems by restructuring loans so that the project becomes financially feasible and able to repay the loan.

I distinguish between the act of restructuring —the actions that the borrower and bank agree to take— and rescheduling the loan, an action that is undertaken after the restructuring is agreed upon and started.

Some way must be found to deal with the interest costs arising from long delays of government regulators and departments that destroy many projects from the accumulated and unplanned for higher interest due.

The banks do a reasonable job at determining who should borrow but a poor job of tracking and assisting the borrower.  When failure becomes normal the willful defaulters flourish.

4.  Cyber Security

The Bangladesh banking system is poorly protected from cyber-attacks.

Even the central bank experienced a terrible theft, still a matter of concern and remains disconnected from SWIFT.

I do not believe Bangladesh Bank can be satisfied with progress towards security.

They should be in a state of panic.

Three things are needed:  First, an assessment of the current conditions and recommendations for action.

This has certainly been done in one way or another, but greater effort is needed.

Second, training programs and certification levels should be established.

This is to encourage young people to take up financial system security as a career.

Third, a special section needs to be established to attack the banks and test their security systems.

This is the only way to have a real idea of the vulnerability of the banks.

You can be sure that the banking system is exposed and the sharks circling.

There is no time to waste in launching an intensive program of raising security and initiating the training and establishing career paths to ensure that the protection against cyber-crime improves.

Bangladesh Bank should have improved cyber security at the top of its to do list.

 

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

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