Moody’s downgrades Bangladesh banking sector outlook to negative

Global credit ratings agency Moody's has revised its outlook for Bangladesh's banking system to negative from stable, citing mounting pressures from a slowing economy and persistently high inflation.

The agency warns that the operating environment for the country's banks is set to weaken as businesses grapple with falling demand and rising costs, partly driven by ongoing supply chain disruptions.

Moody's also pointed to concerns over the government's diminishing ability to support banks in times of stress, further contributing to the negative outlook.

In its latest assessment, the ratings agency said the asset quality and profitability of Bangladeshi banks are likely to deteriorate, as structural weaknesses such as lax regulations and poor corporate governance continue to pose risks.

Despite these challenges, it expects banks' capitalisation to remain stable. Slower credit growth will help offset the impact of weakening internal capital generation, it said. Funding and liquidity conditions are also expected to stay stable, although Moody's noted they will remain tight.

The outlook revision comes as Bangladesh faces economic headwinds, with growth slowing and inflation putting strain on businesses and consumers alike.

Moody's also forecast Bangladesh's real GDP growth will moderate to 4.5% in the fiscal year ending in June 2025 from 5.8% in the previous year.

Key challenges for Bangladesh

Main challenges for the Bangladesh economy stem from political and social unrest that has led to a deterioration of law and order, supply chain disruptions in the ready-made garment sector and a weakening of demand.

The central bank has sharply increased the policy rates from 6% to 10% over a 15-month period between June 2023 and September 2024. "We expect the inflation rate to remain high, at 9.8% in FY25, making it difficult for the central bank to lower its policy rates," said Moody's.

It says high inflation and unemployment rates will limit the interim government's political capital to implement significant reforms. 

The agency finds asset quality will deteriorate as the operating environment worsens. The systemwide nonperforming loans (NPL) ratio, which jumped to 17% as of the end of September 2024 from 9% nine months earlier, will rise further due to a combination of factors. 

Firstly, banks with concentrated exposure to businesses hit by social unrest, are likely to see a significant deterioration in asset quality. Social unrest has severely affected the financial stability of some domestic businesses by reducing demand, disrupting supply chains and creating labour shortages. 

Secondly, structural weaknesses in the banking sector, such as lax regulations and poor corporate governance, will continue to pose asset risks. Thirdly, tighter NPL classification rules will take effect in April 2025.

As asset risks rise, the regulators may offer forbearance for borrowers, which can help banks manage NPLs by allowing them to modify payment terms of defaulted loans, says Moody's. However, such measures would mask asset risks and hamper loan recovery. 

The systemwide NPL provision ratio remained low at 42% as of the end of June 2024, which would decrease even further if loans with modified payment terms are included, says the rating agency that rates six Bangladeshi private banks.

Also, profitability will deteriorate as loan-loss provisions increase. Loan-loss provisions will increase significantly across the system as existing reserves for stressed loans are insufficient, especially in light of rising asset risks. 

Good for strong banks and bad for state banks

According to Moody's, banks with strong fundamentals will see improvements in net interest margins (NIMs) as lending rates remain elevated after the removal of an interest rate cap by the central bank while benefiting from decreases in deposit costs as financially stronger banks will benefit from depositors flocking to safer banks, weaker ones will continue to rely on short-term liquidity from the interbank market.

On the other hand, NIMs for banks with worsening asset quality will decline as the proportion of interest yielding loans shrinks.

Capitalisation will be stable. Banks' internal capital generation will weaken, but moderate loan growth amid the economic slowdown will limit capital consumption. However, current levels of capitalization are low, especially at state-owned banks. 

At the end of September 2024, the average ratio of capital to risk-weighted assets for state-owned banks was 2.5%, below the 9.4% for their private sector peers and far lower than the regulatory minimum. 

Also, state-owned banks will remain undercapitalised because of weak profitability that is strained by high levels of NPLs and the absence of government capital infusions. Insufficient capitalisation gives these banks limited buffers against substantial unforeseen loan losses.

Growing contingent liabilities will pose further risks to banks. Foreign-currency liquidity will remain limited because Bangladesh has small foreign exchange reserves, and its exports are decreasing, although remittance inflows have increased, according to Moody's.