WB outlines 10-point rescue plan for Bangladesh’s banking sector

Key recommendations: 

• Restructuring of state-owned banks
• Establishment of a strong framework to manage NPLs
• Enactment of a comprehensive bankruptcy law
• Adopting international standards in supervision
• Ensuring full independence of central bank

The World Bank has urged Bangladesh to implement a comprehensive set of reforms to restore stability in its financial sector, which it says has been weakened by poor governance, political interference and related-party lending.

In its South Asia Development Update released today (23 April), the WB outlined a 10-point action plan to address long-standing structural weaknesses in the country's banking system.

Top of the list is the restructuring of state-owned banks, alongside the establishment of a strong framework to manage non-performing loans (NPLs) and the enactment of a comprehensive bankruptcy law.

The WB also called for improvements in the bank resolution framework, the deposit insurance system, and corporate governance. Additional recommendations include enforcing banking regulations, adopting international standards in supervision, implementing an emergency liquidity assistance scheme, and ensuring the full independence of the central bank.

While the World Bank's Development Update typically covers broad economic indicators such as GDP growth, inflation, and the external balance, this year's report places special emphasis on the health of the financial sector.

The report describes Bangladesh's banking system as facing "significant challenges", citing persistently high NPLs, inadequate capital buffers, and operational inefficiencies. It also notes that extended regulatory forbearance in loan rescheduling and write-offs has obscured the true extent of distress within the sector.

According to the report, failure to enforce regulations has allowed "zombie banks" – those with negative net worth and severe liquidity problems – to continue operating. Ten such banks account for a third of all loans in the market, with eight facing critical liquidity shortfalls.

"The lack of an effective problem-bank resolution framework has made the sector more vulnerable. As a consequence, the banking sector faces significant strain with worsening asset quality, inadequate capital buffers, and tightening liquidity," said the WB.

The report mentions that the fragility of Bangladesh's banking sector became more pronounced following the political transition in mid-2024, when initial reform efforts were launched. Slower economic growth, driven by political uncertainty, foreign exchange shortages, and weakened investor confidence, has further strained both businesses and financial institutions.

According to Bangladesh Bank data, gross NPLs in the banking industry more than doubled to Tk2.9 trillion ($23.7 billion) as of September 2024. The NPL ratio rose sharply to 20.2% by December 2024. State-owned banks accounted for approximately 46% of the sector's total NPLs, underscoring the deep-rooted issues within public banking institutions.

The central bank anticipates that the NPL ratio could exceed 30% following the implementation of a new international-standard definition of NPLs, which considers loans overdue by 90 days. This updated rule is set to take effect in April 2025 and will be accompanied by stricter enforcement measures.

"The opportunity cost of NPLs is high and limits resource allocation for other sectors," said the WB.

Also, the loan loss provisioning coverage ratio fell from over 52% in September 2023 to 44% in September 2024, reflecting inadequate provisioning against growing credit risks. The provision shortfall stood at $4.5 billion in September 2024. 

"Multiple initiatives are critical to overcome the challenges and strengthen the sector swiftly. International experiences show that banking crises impose substantial economic costs, and prompt recognition and resolution of banking distress can significantly lower the cost of resolution," said the WB.

The report, however, notes that following the regime change in August 2024 and recognising the fragility of the banking sector, the interim government and the Bangladesh Bank have been assessing vulnerabilities in the sector and identifying the necessary reforms to address them.

On the overall economy, the report states that Bangladesh's real GDP growth is projected to moderate to 3.3% in FY25. The overall deceleration of economic activity in the first three quarters of FY25 was driven by a slump in both private and public investment, it notes. Political unrest, violence, curfews and internet shutdowns severely disrupted economic activity in the first quarter of the current fiscal year, it added.

Inflation averaged 10.6% in the first 8 months of FY25 and continued to dampen consumer purchasing power, according to the WB report. Inflation was driven by high food and energy prices and higher import prices as a result of a depreciating taka, it notes. 

Signs of easing price pressures have materialised in Q3 FY25, but the central bank has signalled its intention to maintain the contractionary monetary policy stance, even in the face of weak economic activity, said the WB.

The WB says the recent global trade disruptions are expected to have a limited impact on Bangladesh in FY25, as the disruptions occurred near the end of FY25. The disruptions are expected to have a greater impact on Bangladesh's exports and the economy in FY26, although the scale of the disruptions is difficult to project given significant policy uncertainty. 

"In FY26, international trade disruptions, global economic slowdown, and rising inflation are expected to reduce Bangladesh's exports and real GDP growth by 1.7 and 0.5 percentage points, respectively, compared to previous projections. As a result, in FY26 exports and real GDP are expected to grow at 4.2 percent and 4.9 percent, respectively," said the WB. 

However, the report says lower import payments for fuels resulting from lower international energy prices are expected to partially offset the negative impact on the current account deficit.