World Bank recommends 10 steps to mitigate bank sector risks

The World Bank has made a 10-point recommendation to strengthen the banking sector in Bangladesh, noting that the sector is now facing multifaceted challenges.

In a latest report titled ‘Bangladesh Development Update”, the global financier said the authorities in Bangladesh made commendable efforts since August 2024 to effectively address current banking sector distress.

Still, some key measures can be taken to bolster the banking sector reforms.

Building on the Bank Resolution Ordinance currently under review, authorities should establish a robust bank resolution framework with strong execution capabilities to enable swift intervention and orderly restructuring. This includes implementing a clear classification system for banks based on viability and systemic importance, allowing for the prompt resolution of nonviable institutions while ensuring adequate depositor protection to prevent financial contagion.

Enhance the existing DPS by establishing a clear and efficient payout mechanism that aligns with international standards. This includes ensuring that the Deposit Protection Fund is adequately funded and liquid and strengthening the Deposit Protection Department of the BB.

Authorities should prioritize corporate governance in banks by ensuring that their boards consist of competent professionals rather than political appointees. Management should be granted full operational freedom to mitigate political influences and enhance the integrity of lending decisions. Fit and proper criteria must be implemented for selecting directors of banks, especially State-Owned Commercial Banks. Additionally, the number of independent directors should be increased, and regulatory actions must be taken against any director for wrongdoing, regardless of whether they were appointed by the government. Authorities should require banks to strengthen transparency, internal controls, and independent oversight to ensure early detection of irregularities and compliance with regulatory standards. Banks must also adopt robust comprehensive risk management frameworks, including credit and market risk management, early warning systems, stress testing, and enhanced liquidity management to mitigate financial vulnerabilities.

The authorities should prioritize the reform of SOBs with sustainable financial and business models, ensuring that SOBs are properly supervised and operate on a level playing field related to prudential regulations and competition (OECD 2024; WB 2021). This would help stabilize the financial sector, enhance operational efficiency, and improve resource allocation and financial intermediation. Bangladesh Bank could consider allowing some SOBs to take over its development finance function so that it could focus on its core mandate. Other SOBs could be converted to banks operating on commercial principles. In addition, authorities should ensure SOBs are effectively managed, and the incentives of management and staff should be aligned with the objectives of the institution through effective corporate governance, risk management, and performance evaluation mechanisms.

Authorities should establish a clear NPL resolution framework that includes legal processes, debt restructuring, and operational guidelines for asset management companies. These institutions should be empowered to purchase NPLs, restructure distressed assets, and sell them to maximize recovery, ensuring rapid resolution and minimizing systemic risks.

The existing Bankruptcy Act, 1997, should be strengthened, or a new, comprehensive bankruptcy and insolvency law should be enacted to streamline the liquidation process, protect small investors, and simplify business operations. This should include timebound procedures to expedite resolutions in Money Loan Courts.

The regulator should enforce banking regulations rigorously, with strict punitive measures for noncompliance. This includes implementing regular audits, proper disclosures, and ensuring that all financial institutions adhere to established guidelines. Furthermore, regulators should not allow undue deferral of regulatory requirements to hide the distress of banks.

Implement a robust ELA framework to provide timely and secured liquidity support to banks facing temporary liquidity shortages. This framework should include clear eligibility criteria, collateral requirements, and transparent procedures to ensure that liquidity assistance is provided only to solvent banks with adequate collateral. Additionally, the central bank should regularly review and update the ELA framework to adapt to changing market conditions and mitigate systemic risks.

To strengthen the resilience of the banking sector, Bangladesh should adopt international best practices in banking regulation and supervision. This includes aligning regulatory frameworks with global standards such as International Financial Reporting Standard (IFRS) 9 for better financial reporting, dynamic provisioning to address credit cycle fluctuations, and the full adoption of Basel III including the Internal Rating-Based approach for more accurate risk assessment. Additionally, improving the capacity of regulatory bodies and ensuring timely and effective interventions will help prevent systemic risks and ensure long-term financial stability.

This can be achieved by ensuring that BB operates with full autonomy in its regulatory, supervisory, and decision-making processes. Specifically, the appointment of BB’s governor and key officials would be based on merit and expertise, with transparent and competitive selection processes, free from political interference.

Additionally, BB would be granted full discretion and authority to take corrective actions against non-compliant banks, particularly SOBs, without requiring approval from the Ministry of Finance. BB's financial and operational independence would be enshrined in law, with its funding sources separated from government control to avoid undue influence over its monetary policy and regulatory actions.