The banking sector needs sweeping reforms, not bandages
The finance minister, in his parliamentary budget speech, proposed multiple reforms to bring much-needed discipline to the banking sector. Although little was offered in the way of specifics, it was suggested that a banking commission be created.
There is no doubt that reforms in Bangladesh’s financial sector have been long overdue. Much has been said and written about our country’s rising non-performing loans (NPLs), and it is likely this issue will remain the focus of policy-makers and of the proposed reforms.
Yet, we should not let it escape our minds that NPLs are only an outcome of our weak governance structure and extra-ordinary dependency on institutional loans.
Political influence, a culture of impunity, and lack of transparency all undermine the governance of our banking sector. Scams and loots have been far more common and large-scale than is acceptable. For example, the Hallmark-Sonali Bank loan scam involved a loan of Tk3400 crore.
Poor risk management practices, and lack proper internal controls were the commonly held culprits behind the scam. Even after this incident, not all those who should have been held accountable were brought on to the dock. This is indicative of an overall lack of accountability embedded within our governance structures.
Giving out loans based on political or personal affiliations are unfortunate but common practices. This can lead to concentrating loans to only a few borrowers or one sector, heightening risk and encouraging monopolies. If the bank commission cannot be independent and insulated from these political pressures, there is little scope for meaningful reform.
There are structural problems that a Bank Commission alone is unlikely to solve. Private stakeholders are also a necessary part of the solution to governance. Banks should take care to diversify their risk and conduct sufficient due-diligence before disbursing loans.
To navigate increasing compliance requirements and the complex nature of financial crimes and crises, developing the capacity and knowledge of board members and management could prove to be vital in the coming years. This is especially the case as we aspire to become a global hub for investment.
One cannot help but notice a major disconnect in the way our banks operate. There is a disproportionate number of retail branches -- Bangladesh has one of the highest concentrations of bank branches in South Asia despite being a relatively small country.
We must ask ourselves whether this is necessary or are retail locations a major source of inefficiency, especially since these branches tend to be located in some of the most affluent areas of the country.
After all, the force of technology is likely to disrupt the banking sector on a global scale and Bangladesh is no exception. Bangladesh’s penetration rate of unique subscribers of mobile services has risen drastically in the last 20 years and is forecast to increase further.
The number of mobile money agent outlets per 100,000 adults has risen from 186.56 to 666.76 between the period from 2013 to 2017. If this trend continues, retail locations will become an unnecessary burden on banks’ overheads undermining their profitability.
Additionally, there are doubts if the creation of the high number of banks has been driven organically by market demand. Licenses for private commercial banks in the last decade or so are speculated to have been approved due to political motivations and affiliations. It is then not surprising that these banks tend to be burdened by high NPLs and high losses.
Poor asset and liability management presents a threat to banks’ profit margins. The payback period for their liabilities (deposits) tends to be much shorter (one to three years) than the period for their loans (assets), which can be as high as 12 years. This discrepancy in time exposes banks to a myriad of risks including market risk and liquidity risk.
Product-offering is another area where there is substantial room for improvements. The financial sector as a whole has the tendency to depend excessively on banks given that we lack bond and equity markets and non-bank financial institutions.
Although the budget hinted at the creation of financial instruments, this will not be without hurdles. Investors tend to prefer higher yielding and familiar government securities than corporate bonds.
There is thus an awareness gap where investors are reluctant to invest in the bond market. High issuance costs and other capital market constraints deter corporations from entering the bond market.
Whether we can develop our bond markets will depend on the liquidity of bonds and necessary collateralization and securitization of related instruments.
A roadmap for the establishment of a robust bond market could include awareness and educational programs for investors, appropriate regulations, an effort to reduce costs of bond issuance, and financial incentives for issuers and investors.
The product-offering of our banks also maintains a focus on interest-earning products which involves undertaking a high level of credit risk and balance sheet risk. If the model were to shift its focus to products that earn fee-income, it might reduce the exposure to such risks. Examples of such products include ATM fees, checking account fees, wealth management services, products linked to capital markets, and other advisory products.
To successfully make this transition, it is imperative that banks invest in building their customer service and their reputation. Banks must strive to gain their customers’ trust and brand loyalty. Investment in new and efficient technological platforms will lead the path forward.
Investing in people is also a key ingredient in creating reform for banks. Human Resource (HR) departments of banks should be developed to be meritocratic, and ethical in their hiring decisions. This is likely to curb compliance oversights by staff, excessive risk-taking behaviour and cronyism.
Our banking sector could substantially benefit from the improvement of our technological infrastructure. The Bangladesh Bank heist in 2016, for example, was at least partially caused by weak IT security as the bank had no firewall in its network.
Particularly, with sufficient investment in cyber security and sophisticated risk management techniques, we could make security systems ironclad. Banks would do well to use Management Information System (MIS) as this would better enable them to catch malpractices and protect their capital without delay.
Given the plethora of problems, policymakers must take a long-term, reformist outlook, and not one that is merely operational. And to me, a strong and forward-looking central bank is enough to drive those much-needed reforms, not the people from the academic world or retired bureaucrats.
Mamun Rashid is a leading economic analyst.