How banks made record profits in a depressed year

Highlights:

• Most Bangladeshi banks profit from government securities, not traditional lending
• BRAC and City Bank join exclusive Tk1,000 crore profit club
• Banks prefer risk-free returns over private sector loans, analysts warn
• High government borrowing raises yields, crowding out private credit
• Rising default loans cause major losses for many struggling banks
• Economists blame excessive government borrowing for distorting banking incentives

In a challenging 2024, the majority of Bangladesh's 36 listed banks struggled to turn a profit, with only about a dozen succeeding.

What's more, these profits weren't primarily driven by interest income, traditionally the core business of banking. Instead, a significant shift towards government securities is underpinning the profitability of a select few, raising questions about credit availability for the private sector and the broader health of the economy.

Stock market data reveals that nine of these profitable banks saw their earnings surge thanks to increased investments in government securities. This comes as most other banks reported a decline in interest income, reflecting a slowdown in private sector credit growth.

The Tk1,000 crore profit club

In a notable development, two local banks, BRAC Bank and City Bank, joined the exclusive "Tk1,000 crore profit club" for the first time. They stand alongside foreign banks that also posted record-high earnings in a year marked by a severe crisis in the banking sector amid broader economic turmoil. Both BRAC and City Bank achieved these record profits despite a decline in their net interest income, a direct result of their substantial investment in government securities throughout the year.

A shift to risk-free returns

Analysts are quick to point out that when banks increasingly rely on government securities for profit, it signals a strategic shift towards risk-free returns and away from traditional lending. This trend could potentially reduce the availability of credit for businesses and individuals, thereby hindering private sector growth.

Government securities offer predictable and reliable returns, making them an attractive source of income for banks during periods of economic uncertainty. The high yields on these securities over the past year further incentivised banks to invest heavily in treasury bills and bonds. As the government increasingly leaned on banks to finance its budget amidst low revenue collection, yields on government securities rose above 12%, significantly higher than the private sector lending rates which hovered just above 10%.

"What the banks are doing is parking their loanable funds in high-yield, safe assets – because such opportunities are available. Who wouldn't?" commented Zahid Hussain, former lead economist at the World Bank's Dhaka office.

Economic implications

However, analysts warn that an over-reliance on government securities by banks could delay the recovery of the private sector and lead to slower overall economic growth.

"There is also the issue of what the government is doing with the borrowed money. If the utilisation boosts the economy's productivity, then the borrowing will eventually pay for itself. Banks have no role in that process," Hussain added.

The context for this shift is a liquidity crisis faced by most banks, triggered by widespread loan-related corruption over the past 16 years. The few banks that maintained a strong liquidity position largely opted to invest in government securities over the past year. This reduced lending to the private sector has resulted in sluggish private sector credit growth, which by year-end had fallen to 7%, well below the monetary target of over 9%.

The growth drivers: BRAC and City Bank

BRAC Bank reported a net profit of Tk1,213 crore in 2024, a remarkable 66.2% increase from the previous year and the highest among local banks. Yet, its financial statement shows a 24% decline in net interest income, while investment income from government securities surged by a staggering 240.6%. The bank's loan book grew by 20%, significantly less than its 80.5% increase in investments in government securities, indicating a clear strategic shift towards government instruments amidst weak credit demand.

In a stock market disclosure, City Bank stated that its "Operating profit increased as a result of a significant increase in investment income, which helped offset de-growth in net interest income and pay for rising operational costs." City Bank reported a historic 76.4% growth in net profit, reaching Tk1,085 crore – the second-highest profit in the banking industry. Despite this strong bottom line, the bank's net interest income declined by 8.5%, while investment income from government securities soared by 375.3% in 2024. City Bank's loan book grew by 12.3%, contrasted with a 96.1% jump in its investment in government securities, a key factor in its record profit.

These record profits for a few banks come at a time when the country's GDP growth has slowed to 3.97% in FY25, its lowest since the post-COVID period, down from 4.22% in the previous fiscal year.

"There is almost a universal perception in the developing world that government risk is safer than corporate or even institutional risk. Besides, interest rates on government securities have gone up significantly in recent times due to heavy borrowing by the government to cover revenue deficits, even depriving the private sector," said Mamun Rashid, former banker and chairman of Financial Excellence Ltd.

Several other banks, including Prime Bank (Tk744 crore profit, up 53.9%), Mutual Trust Bank, Jamuna Bank, and Bank Asia, also recorded significant profit growth in 2024, primarily due to increased investments in government securities, even as their net interest income declined.

The bleeding of default loans

However, this profitable trend was not universal. Many banks suffered losses in 2024 due to a sharp rise in default loans, following the central bank's exposure of massive loan scams under the previous regime. Islami Bank, once a top profit-making bank, has yet to finalise its annual report for 2024 due to significant financial losses driven by a surge in default loans, with its default loan ratio skyrocketing to 27.38% in March this year, up from just 4% at the end of 2023. Other banks like Social Islami Bank, First Security Islami Bank, and United Commercial Bank (UCB), which previously posted strong profits, slipped into losses in 2024, primarily due to increased provisioning requirements triggered by rising default loans.

The root cause: Government borrowing

Economist Zahid Hussain identifies the government's domestic borrowing as the real issue. "As long as that remains unchanged, the government will find the money from some source – banks, nonbanks, or both. It will have to offer interest rates high enough to make its bills and bonds attractive, and that, in turn, will translate into higher borrowing costs for corporates, small businesses, and retail loans," he explained.

"The root cause, therefore, is the volume of government borrowing from banks and how those borrowed funds are utilised. Banks, like any other profit-oriented institutions, simply respond to what the market offers."

"If we want public money to be used for non-interest expenditures, the only way to achieve that is by reducing public debt. Easier said than done!" Hussain concluded, highlighting the complex challenge facing the nation's financial landscape.