The US-based credit rating agency, S&P Global Ratings (previously Standard & Poor's, and informally known as S&P), has recently published an assessment report titled "Banking Industry Country Risk Assessment: Bangladesh." It reads that credit risk in Bangladesh is extremely high due to weak foreclosure laws, underwriting standards and weak governance at some banks.
Foreclosure law provides the means for the lender to take possession of the assets of the borrower in the case of default. Of course, there are shortcomings but foreclosure laws are especially weaker when it comes to enforcement.
"For credit recovery, we take longer time than necessary. Moreover, the credit recovery mechanism in the legal process does not work in Bangladesh," said Professor Shah Md Ahsan Habib, Bangladesh Institute of Bank Management (BIBM).
But the good news is that in May 2021, the cabinet approved the draft of Bank-Company (Amendment) Bill 2021 to control default loans and ensure good governance along with stability in the financial sector. In the existing Bank-Company Act 1991 law, the definition of the deliberate loan defaulters and actions against them are not clearly defined. But the latest bill is an improvement.
"But once the amendment is put into effect, proper monitoring will be possible, and we will be able to amend the existing loopholes by taking actions against them [the defaulters]," said Professor Ahsan.
S&P has also mentioned that overcapacity and market distortions (market distortion is the lack of free and open competition in a market) are some of the prominent reasons for credit risk. But in a developing country like Bangladesh, market distortion is not a weakness rather it is a necessity for us.
"We cannot offer a 17% interest loan to our farmers or SMEs. Even a developed country like America has this market distortion system and they have lower interest rates for their farmers. Then why cannot we? Hence, governmental intervention is necessary to fix market distortion," said Nehal Ahmed, Director of Dhaka School of Bank Management (DSBM).
He also added, "We generalise good governance and put all the blame on our governance, but there are good examples too. For instance, among 61 private banks, about 40 banks in Bangladesh have below 5 percent non-performing loans (NPL), which is a global standard rate.
So, good governance is not non-existent in Bangladesh. But, yes, there is more room for improvement. We cannot directly mention this as poor asset quality [represented by non-performing loans or impaired loans]." further explained, Nehal Ahmed.
As poor asset quality is not the biggest problem, capitalisation of banks still seems like an issue. But Nehal explained, "To keep banks stable, injection of capitalisation is not anything harmful, specially for government operated banks. It keeps those banks running."
Another reason for high credit risk in Bangladesh, according to S&P's report, is not having a strong supportive core customer deposit, who deposit their money under different saving schemes. In a way, this allegation is accurate. In most banks, core customers are not treated well. Therefore, their interest in depositing is decreasing. But this culture seems to be changing nowadays, as banks are trying to value their core depositors.
Moreover, S&P has pointed out that over-reliance on external funding is not justified given the existing banking scenario in Bangladesh. Agreeing with this, Professor Ahsan said, "There are valid reasons not to rely on external funding. We did not forget the East Asian crisis in 1997. What if the currency exchange rate collapses again?"
He also added, "The Bangladesh government is prudent enough to play it safe. However, the S&P report is mostly written from the developed countries' perspective, not from Bangladesh's perspective. There are more factors at play."
Moody's Investors Service (Bond Credit Rating Business based in New York) has recently said in an analysis report that credit risk of Islamic banks in Bangladesh has increased more than other banks. Moody's analysis report was based on their review of the latest financial stability report by Bangladesh Bank and published in August 2021.
According to Moody's, as of March 2021, 75% of Islamic banks' total loans had gone to corporate loans. But just five years ago, it was only 52%. On the contrary, conventional banks have reduced the loan up to 4%. As a result, Islamic banks are at greater risk than most conventional banks.
As a result, the high credit risk lingers mostly on Islamic banks, as their security reserves are weaker than conventional banks. Furthermore, they might lag in terms of capital improvement in the future.