Why a banking crisis is brewing in Bangladesh

Behind the positive headlines and impressive growth, crony capitalism is pushing non-performing loans towards unsustainable levels.
Sheik Hasina
Sheik Hasina

It is recording the highest growth rate in Asia, but Bangladesh’s boom is fuelling the same kind of banking bust that precipitated the Asian Financial Crisis say fund managers and local analysts.

On the surface, Bangladesh is doing well. The International Monetary Fund (IMF) forecasts that it will hit a growth rate of 7% in 2018 and again in 2019, higher than any other Asian nation including Vietnam.

Such a pleasing headline number prompted HSBC to describe the country as “Asia’s best growth” story in a wide-ranging research report published in April. It concluded that Bangladesh “isn’t getting the attention that it deserves".

That seems highly likely to change in the coming months, although not for any positive reasons. Over the short term, the country is likely to be catapulted back into the headlines because of its looming general election in December.

All eyes will be focused on the bitter rivalry between the two begums – Sheik Hasina Wazad and Khalida Zia – who have been slugging it out for the past two decades. The latter is currently in jail on fraud charges, while the former hopes to secure her third consecutive term as prime minister, leading the Awami League.

The last general election in 2014 was married by violence between the two parties. Yet this time around, financial experts believe the real trouble is likely to erupt afterwards, as problems within the banking sector reach a tipping point.

Marshall Stocker, portfolio manager at Boston-based Eaton Vance told FinanceAsia: “The banking sector has been my main focus for the past year and I’ve become increasingly worried about what might trigger a full blown crisis and when.”

The ‘official’ NPL figure for Bangladesh stood at 19% in June 2018 according to City Brokerage  research citing Bangladesh Bank figures. Recorded NPLs constitute about two-thirds, with rescheduled and restructured advances (from a previous downturn in 2013/4) the remaining one-third.

However, local experts believe ‘real’ NPLs are much higher than this level and now account for a quarter of all loans.

IMF research shows this latter figure is getting very close to the 30% median level that low- and middle-income countries peak at when they experience a banking crisis. For example, Indonesian NPLs peaked at 32.5% at the height of the Asian Financial Crisis and Thai NPLs at 34.8%.

NPLs are also shooting up extremely quickly. The 'official' ratio rose 19.2% during the first three months of the year to Tkr885.89 billion ($10.7 billion).

Nafeez Al Tarik, City Brokerage's head of research and investment in Dhaka, believes that once they breach the 20% threshold, the government will act under pressure from external agencies such as the IMF and other development partners. He also believes it will do so once the election is out of the way.

“The government will then have five years to introduce measures that won’t be popular in some circles,” he told FinanceAsia. “We still have time to sort things out.”

HARVESTING DEPOSITS

However, it is not clear why the government might voluntarily change tack having spent the past five years handing out banking licences to politicians connected to the ruling Awami League. In 2013, it handed out nine licenses to banks sponsored by ruling party politicians.

It is also now evaluating a new round of licences for more banks associated with MPs, including Bangla Bank, sponsored by ruling party MP Morshed Alam, and People’s Islami Bank, sponsored by MA Kashem, who oversees the party’s US wing.

Local bankers say seven of the nine banks, which were set up in 2013, are now experiencing financial difficulties. The nine only account for 5% of system-wide assets, but their NPLs rose 300% in the year to March, according to City Brokerage figures.

Their problems are symptomatic of the issues facing the system as a whole, or “pilferage” as Finance Minister AMA Muhith himself recently put it.

One of the nine, Farmers Bank, has already collapsed, although instead of letting the bank go under, the government has chosen to prop it up instead. Eaton Vance’s Stocker says its problems were thrown into sharp relief late last year when it placed newspaper adverts imploring depositors not to launch a run on it.

“Investors start to get very, very worried when they see banks doing things like this,” he explained with some measure of understatement.

Muhith has previously concluded that Farmers Bank’s problems stem from the fact its “founders have looted the bank". Its chairman and former Home Minister, Muhiuddin Khan Alamgir, was forced to step down earlier this year. 

A group of four state-owned banks and one investment institution subsequently bought 60% of its equity. The next step will be to inject fresh capital via a subordinated bond issue even though the four state-owned banks have their own pressing NPL and capital issues to contend with.

The most hard-pressed of the four is also Bangladesh’s largest commercial bank by assets, Sonali Bank. At the end of 2017, it reported an NPL ratio of 35.09% according to S&P Global Market Intelligence figures.

Moody’s believes Farmers Bank’s re-capitalisation is credit positive for the sovereign’s Ba3 rating because it reflects the government’s “willingness and ability to provide financial assistance to privately-owned lenders".

Not everyone agrees. “The government needs to let some banks fail so depositors understand the risks of investing in these kinds of institutions and migrate towards Bangladesh’s better run banks,” said one local banker. “That will create a virtuous circle enabling those banks to draw deposits at lower cost.”

However, Muhith’s attitude makes that unlikley. “In Bangladesh, there is no track record of a bank collapse,” he told local reporters last year. “This is not allowed to happen.”

1997 RE-VISITED?

The country’s problems are, in so many ways, a replay of what happened across Asia in the run up to the 1997 crisis when high economic growth allied with long-standing political regimes provided an unfettered opportunity for widespread plunder by a nexus of connected politicians and businesspeople.  

Similar to Southeast Asia in the 1990s, Bangladesh also has far too many financial institutions – 57 commercial banks, 34 non-bank financial institutions, 72 insurance companies, 488 depository participants and 784 microfinance institutions at the last count. The government has previously claimed it needed to award new licences because Bangladesh was under-banked and it wants to promote financial inclusion.

Certainly, financial inclusion has improved in recent years. The World Bank’s Findex report shows that the number of adults with financial accounts rose from 31% in 2014 to 50% in 2017. But that jump was thanks to just one institution: privately owned BRAC Bank and its enormously popular bKash mobile banking app (Ant Financial owns a stake).

Bangladesh’s problems have not quite reached the industrial scale they did in Indonesia, which had 240 banks in 1997. But the underlying situation is exactly the same – too many well-connected people own a captive bank, which takes money from ordinary depositors and then mismanages it by lending to affiliates or worse.

Like Bangladesh, Indonesia averaged a 7.1% growth rate between 1987 and 1996. Like Bangladesh, it did not have developed capital markets to manage the financial flows such high growth generated. The money all pooled into and then seeped out of a defective banking system instead.

There are some bright spots. Bangladesh has a handful of well-run banks and investors have rewarded them by pushing their market capitalisations above $300 million (BRAC, Eastern Bank and City Bank). 

But the well-run banks have also been handicapped by the government’s National Savings Certificate Scheme. This offers 12% returns – twice the inflation rate.

Investment per person is capped at Tk45 laks ($53,700). However, Al Tarik says the government has no mechanism to track whether anyone abides by it.

“The government also needs to improve the central bank’s supervision and enforcement so that errant banks are penalised,” he said. “Then there’s the problem of managing NPLs. The process to manage delinquencies is extremely slow, costly and complicated.”

The government set aside Tk2,000 crore ($239 million) for capital injections into its ailing state-owned banks during the 2016/17 financial year. It previously injected Tk11,705 crore ($1.4 billion) between 2009/10 and 2015/16.

It is a tax on the most productive sectors of the economy and if the banking system teeters over it will cost a whole lot more. Indonesia ended up spending 56.8% of its GDP to bail out its banking sector during the Asian Financial Crisis. It recovered less than a quarter of that from asset seizures.

“I believe Bangladesh is capable of double-digit GDP growth,” Al Tarik concluded. “Every year 4% of our 163 million people are entering the labour force, but our dysfunctional banking system is holding that back.”

¬ Haymarket Media Limited. All rights reserved.

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