Central bank's roadmap for banking sector reforms

Bangladesh Bank has unveiled a roadmap aimed at addressing the prevailing issues within the country's banking sector. This comprehensive plan integrates many of the reforms advocated for within the banking industry over the years.

The approval for this roadmap was given during a recent board of directors meeting held on Sunday. During a subsequent press conference, Deputy Governor Abu Farah Naser of the central bank provided detailed insights into the roadmap. Central bank sources indicate that prior to its public announcement, the roadmap had received high-level approval from the government.

The roadmap comprises action plans targeting 17 key issues. Among these, five are deemed particularly significant. They include the reduction of defaulted loans, the prevention of anonymous loans and fraudulent activities, the establishment of mechanisms for appointing competent directors, the appointment of qualified independent directors, and the consolidation of weaker banks through mergers with stronger ones.

Bangladesh Bank has outlined three primary goals as part of its roadmap for reforming the banking sector: 1. To reduce the overall non-performing loans (NPLs) of banks to below 8 per cent, which currently stand at just under 10 per cent. 2. To lower the NPLs of state-owned banks to 10 per cent and those of private banks to 5 per cent, which presently hover around 22 per cent and 7 per cent respectively. 3. To ensure robust governance within the banking sector, aiming to eliminate over-lending, anonymous lending, and fraudulent loan disbursement.

The deadline set by Bangladesh Bank to achieve these targets is 30 June, 2026. Deputy Governor Abu Farah Naser conveyed this during the press conference, emphasising that subsequent actions will align with the outlined roadmap.

While stakeholders who have long voiced concerns about governance issues in the banking sector have welcomed Bangladesh Bank's roadmap, some remain skeptical. They assert that measures should be taken to address issues related to businessmen closely linked to the government. The extent to which Bangladesh Bank can address these concerns remains to be seen in the forthcoming days.

During the past three terms of the Awami League government, the banking sector in Bangladesh has faced significant criticism. Bangladesh Bank has come under scrutiny for its alleged involvement in various controversial practices, including granting banking licences based on political affiliation, permitting unscrupulous individuals to assume positions as bank directors, allowing certain groups to exert undue influence over banks, and engaging in arbitrary irregularities such as appointing family members and relatives to key positions within banks. Moreover, concerns have been raised about the issuance of anonymous loans and other questionable practices.

The issue of defaulted loans has exacerbated over time. In 2009, defaulted loans stood at approximately Tk 225 billion, but they have since skyrocketed to exceed Tk 1.55 trillion.

However, insiders within the banking sector estimate that the actual amount of defaulted loans could be as high as Tk 4 trillion. If anonymous loans are taken into account, this figure could climb to Tk 6 trillion.

The country's economy currently faces significant challenges, and economists have emphasized the need for substantial reforms within the banking sector to address the crisis.

In the Awami League's election manifesto for this year, the party pledged to establish discipline within the financial sector, combat financial crimes, curb the repeated rescheduling of defaulted loans, and ensure the independence of commercial banks.

The subsequent unveiling of Bangladesh Bank's roadmap appears to be a step towards fulfilling these promises and addressing the pressing issues within the banking sector.

Bangladesh Bank has outlined several action plans within its roadmap aimed at reducing defaulted loans, one of which involves the process of writing off such loans from the bank's balance sheet.

According to the central bank's guidelines, if a loan remains bad or defaulted for a continuous period of two years, it should be written off, with the bank maintaining 100 per cent security against these loans.

This security is usually derived from the bank's profits and is known as the security reserve. Additionally, Bangladesh Bank stipulates that if a loan defaults for three consecutive years, it must be classified as a write-off.

Bangladesh Bank has provided an estimate of the potential reduction in defaults resulting from the implementation of the write-off policy. According to their projections, writing off loans that have been in default for two years would decrease the total non-performing loans to slightly over Tk 430 billion, constituting 2.76 per cent of the bank's total loans.

Importantly, the central bank asserts that there will be no additional risk for the bank associated with the implementation of the 100 per cent security reserve requirement.

The roadmap includes the establishment of a separate unit named the 'Write-off Loan Recovery Unit' tasked with the direct oversight of the recovery process for defaulted loans. The managing director or chief executive of the bank will supervise this unit, and meeting the loan collection targets will be added in their performance evaluation.

It's crucial to understand that writing off defaulted loans doesn't equate to their recovery. If borrowers fail to repay, the defaulted loans will ultimately be absorbed from the bank's profits, which directly impact the shareholders. In essence, if defaulted loans are written off without recovery, shareholders will incur losses.

Furthermore, the roadmap proposes legislation for the creation of wealth management companies within the private sector. These companies would facilitate the cleanup of banks' financial statements by purchasing bad loans and written off loans. The proceeds from such sales could then be reflected as income by the bank.

Bangladesh Bank has also emphasised that the additional period granted for loan repayment will not be extended. The regulatory body believes that this measure will help alleviate the liquidity crisis faced by banks. Additionally, revisions to the definition of bank overdue loans are also expected to be implemented as part of the reforms outlined in the roadmap.

The roadmap outlines several key policies aimed at addressing willful defaulters and enhancing governance within the banking sector. Among these initiatives, the formulation and implementation of necessary policies to take action against willful defaulters is highlighted. Additionally, the roadmap proposes the introduction of a special allowance for officers who successfully recover defaulted loans. Moreover, it mandates that loan collateral must be compulsorily assessed by listed companies.

Bangladesh Bank has announced six plans to ensure good governance within the banking sector. This includes revising policies related to the qualifications and responsibilities of stakeholder directors, as well as formulating policies regarding the appointment, remuneration, and responsibilities of individual directors.

Furthermore, changes have been made to the selection process for the appointment and re-appointment of managing directors (MDs) of banks, which will be enforced more rigorously. The performance of MDs will be evaluated based on indicators of performance and competency.

Regarding bank mergers, the roadmap stipulates that employees cannot be terminated for three years following a merger. Additionally, the recruitment of professionals within the bank will involve several steps outlined in the roadmap to ensure transparency and effectiveness in the process.      

Determining which banks are weak and which are strong is a significant challenge. Deputy Governor Abu Farah Naser mentioned in yesterday's press conference that banks have been encouraged to assess their financial indicators independently. They will need to discern the stage their bank is at themselves. 

However, the concern arises: will some banks with a propensity for at irregularities and concealing their discrepancies, portray themselves as weak or not?

Ahsan H Mansur, the executive director of Policy Research Institute (PRI), told Prothom Alo “The financial health information provided by most banks is not credible. Independent special audits in weak banks listed as suspects should be conducted. The boards of directors of these banks should be dissolved prior to the audit.”

While welcoming Bangladesh Bank's roadmap, Ahsan Mansur emphasised the necessity for the central bank to diligently implement the reform measures. He stated that soft approaches would not be effective and emphasised the need for robust action. However, doubts remain regarding the extent of political will for these reforms.