‘No need for so many non-bank financial institutions’

The non-bank financial institutions - commonly known as NBFIs - may have become exposed to market volatilities because of their overdependence on a small number of large investors and debtors.

According to Bangladesh Bank, 56.2 percent of all deposits in NBFIs were between Tk1 crore to Tk50 crore. Moreover, only 5,019 depositors across the entire NBFI establishment were responsible for these deposits. In terms of loans, 60.6 percent of total funds were distributed among only 6,587 borrowers. 

Pundits fear that if a large chunk of these large depositors withdraws their funds for some unforeseen economic shock (like the Covid-19 pandemic) or a dip in confidence in the market, the NBFIs may face a liquidity crisis. 

Given the rather contentious track record of the NBFIs, such fears may not be totally unwarranted. For instance, in 2019, People's Leasing and Financial Services (PLFS), a non-bank financial institution, barely avoided liquidation owing to an order from the High Court ignoring a plea from the central bank. 

Previously, the Government of Bangladesh had ordered the central bank to liquidate the NBFI for deteriorating financial performance for protracted periods. 

On top of that, in 2021, Bangladesh Bank declared that 13 out of the 34 NBFIs currently operating in Bangladesh had slipped into the red zone by the end of 2020. The number used to be 10 back in 2019.

Generally, infection rate, defined as the ratio of non-performing loans to total distributed loans is the main metric for categorising financial institutions into three zones: red, yellow and green, with the colours corresponding to weak, moderate and satisfactory performance, respectively. 

Experts cite systemic problems such as a high degree of non-performing loans and lack of oversight from the central bank as some of the issues plaguing the NBFI sector.

The Business Standard wanted to get a more refined understanding of the inner workings of the NBFI industry and seek a potential way out for the NBFIs. So, we asked Dr Saleh Uddin Ahmed, the former Governor of Bangladesh Bank, to share his two cents on the matter. 

Dr Saleh Uddin Ahmed, the former Governor of Bangladesh Bank. Illustration: TBS

After four decades of operation, the lending and borrowing activities of the NBFIs remain confined to a few thousand large debtors and creditors. Why haven't the NBFIs been able to expand their operation to an expected degree?

This problem is not exclusive to non-bank financial institutions. All financial institutions, bank or non-bank, are overexposed. Whether we talk about the banks or the NBFIs, the main problem is their tendency to run after large debtors and creditors while ignoring the small business debtors. 

They do this because by distributing large amounts of loans to a small number of clients, they hope to remain in control while generating a considerable amount of revenue, despite putting in very little effort. While the larger banks do have the capacity to monitor their debtors, most NBFIs have limited resources and cannot do so. This is probably why they prefer keeping a relatively smaller and manageable roster compared to typical financial institutions like banks.

According to Bangladesh Bank, 56% of all deposits in the NBFIs belong to only 5,019 creditors. It is feared that a wholesale withdrawal of these deposits or the failure of large debtors to repay their loans may leave the NBFIs vulnerable to potential shocks. Is this fear reasonable?

The NBFIs are currently held hostage by large debtors. They understand that financial institutions rely on them for both lending and borrowing. As a result, debtors tend to take out multiple different loans from different financial institutions at different periods in time. 

For instance, if they have to repay their loans at a bank, they would take out another large loan from an NBFI to repay the other one. The NBFIs cannot do anything about this as they have to compete with other financial institutions to get these clients and their reluctance to comply with the client's request would drive the clients away. 

Moreover, most NBFIs - even if they were willing to - do not have the capability or human resources to monitor their clients. To make matters worse, there are many reports of irregularities within the NBFI establishment like their directors being corrupt or being involved in shady practises. All of these factors together exposed these institutions to the risks you mentioned.

Do you believe that the recent scandals in the banking as well as the NBFI sector, such as the liquidation of People's Leasing and Financial Services (PLF), have adversely affected the confidence of the customers in the NBFIs?

There are too many NBFIs currently operating in Bangladesh. But people only know and trust a handful of them. They either never heard of the other ones or do not have confidence in their operations. 

Moreover, the NBFIs are not as strictly regulated by Bangladesh Bank as other financial institutions. They do not have to strictly abide by the CRR (Cash Reserve Ratio: The percentage of total funds a financial institution is required to keep as cash to prevent a liquidity crisis) announced by the central bank. 

In short, the typical norms in the financial industry do not always apply to them. That's another reason creditors do not trust them very much. Scandals like the PLFS liquidation only worsen this situation.

Bangladesh Bank says that the greatest failure of the NBFIs is in releasing expedient products. Do you agree?

Currently, there isn't a market for so many NBFIs in Bangladesh and most of these institutions aren't even trying to diversify their products or introduce packages that would attract new customers and expand the market. From the beginning, they should have focused their operations to serve small and medium enterprises. But instead, they choose the easy way out by picking and choosing some large debtors and creditors to manage their operations and generate revenue. 

These NBFIs do not diversify their portfolio nor do they pursue other measures of offsetting risks such as hedging (a risk management strategy that offsets losses by taking an opposite position in a related asset), risk-sharing and securitisation of debts. In short, they are neither diversifying their clientele nor their products. They put all of their eggs in one basket and we are observing the result of that decision now.

On top of that, many banks have invested large sums of money in the NBFIs and due to their poor performance, many banks have also become exposed to the risk of these NBFIs going belly up.

How can the NBFI sector reach its true potential? What steps should be taken by the central bank and the GOB to achieve this goal?

There are many NBFIs in name only, which do not contribute much to the financial sector. When I was the Governor of Bangladesh Bank, I saw many of these NBFIs could not even properly pay the salaries of their employees. So, I would recommend withdrawing the licence of these institutions and merging those with poor performance with larger ones with better track records. 

In the case of the large financial institutions in trouble, bail them out of this situation and restructure their management. Some may argue in favour of liquidation, but such measures will not solve the problem.

The next step would be to improve the financial management and financial reporting system. Assuming that financial institutions exhibit prudent management and reporting, they can release shares in the stock market to raise their capital base. Without the injection of new capital, it is unlikely that the NBFIs will be able to expand beyond their current capacity.