Banking sector reform: The case for consolidation and structural change

Bangladesh's banking sector is characterised by fragmentation, weak governance, and a persistent deterioration in asset quality. Relative to the size of its economy, the country operates an excessive number of commercial banks. 

This has contributed to capital dilution, rising non-performing loans (NPLs), repeated governance failures, and an inefficient allocation of credit. These structural weaknesses now require decisive policy intervention.

Bangladesh currently has 52 local commercial banks across public and private ownership, in addition to nine foreign-operated branches, for a total of 61 scheduled commercial banks. By contrast, India, with a significantly larger economy and population, has 33 domestic banks. 

Over the past two decades, India pursued a deliberate consolidation strategy through mergers and acquisitions, reducing the number of institutions while strengthening capital adequacy, governance standards, and operational efficiency. As a result, gross NPL ratios for Indian scheduled commercial banks have fallen to approximately 2.3%, their lowest level in more than a decade.

This divergence reflects differences in regulatory discipline, political commitment, and institutional capacity. Bangladesh must now confront a fundamental policy question: whether to continue expanding the number of banks, or to prioritise a smaller number of stronger, better-governed institutions.

The current vulnerabilities in Bangladesh's banking sector are the cumulative result of long-term policy distortions. The system-wide NPL ratio reached 20.2% in December 2024. State-owned commercial banks are in a significantly worse position, with aggregate NPL ratios exceeding 30%, and individual institutions such as Rupali Bank and Agrani Bank reporting NPLs approaching or exceeding 40% of total loans. 

Regulatory forbearance, including repeated loan rescheduling and write-offs, has obscured the true financial condition of many banks, weakened market discipline, and reduced the reliability of financial reporting.

Over the past 15 years, roughly 16 new bank licences have been issued, many under political pressure rather than on the basis of market need. In 2013 alone, nine new licenses were granted. 

In a relatively small and saturated market, this expansion has intensified competition for limited credit opportunities and, in several cases, encouraged high-risk lending. Combined with weak enforcement against defaulters and sustained capital flight, this has left multiple institutions in a fragile financial position.

Recent governance interventions, including the restructuring of boards at several private banks and the formation of task forces by Bangladesh Bank following the political transition of 2024, highlight the depth of systemic weakness. 

State-owned banks continue to operate with significant capital shortfalls and depend on implicit sovereign support. Under standard prudential norms, several would be considered insolvent. This creates contingent fiscal liabilities and continues to erode depositor confidence.

International experience points clearly toward consolidation. Following the 1997 Asian financial crisis, South Korea implemented a comprehensive restructuring programme that forced mergers among weak banks, reduced systemic risk, and strengthened capital buffers, enabling a subsequent transition toward a technology-driven financial system. 

Malaysia undertook an even more dramatic restructuring, consolidating 54 financial institutions into 10 anchor banking groups. These institutions achieved economies of scale and improved risk management capabilities, expanding access through digital platforms. India advanced financial inclusion through digital infrastructure, reducing reliance on physical branch networks. Brazil's payment ecosystem further demonstrates how technology-led systems can enhance efficiency and broaden financial access significantly.

These precedents suggest that policy emphasis should shift from increasing the number of institutions to strengthening their balance sheets, governance frameworks, and technological capacity.

For Bangladesh, a comprehensive reform agenda must begin with a transparent and credible assessment of asset quality across all banks. Where discrepancies are suspected, independent forensic audits are necessary. Policy decisions must rest on accurate, verifiable data rather than on figures distorted by rescheduling and write-offs.

Consolidation should form the central pillar of reform. The government can initiate mergers among state-owned banks, combining weaker institutions with relatively stronger ones to create a smaller number of viable entities. Select institutions may also be considered for privatisation, subject to appropriate regulatory safeguards and market conditions. 

Ongoing consolidation processes, including proposed mergers among Shariah-based banks, should be resolved promptly to remove uncertainty and restore confidence. A clear policy position should also be established against the creation of additional state-owned banks.

Bangladesh must now confront a fundamental policy question: whether to continue expanding the number of banks, or to prioritise a smaller number of stronger, better-governed institutions.

Regulatory reform is equally critical. Bangladesh Bank must be granted genuine operational autonomy and held accountable for maintaining financial stability. Leadership appointments should prioritise professional competence and independence from political influence. Licensing standards for new banks must be significantly tightened, with clear and enforceable criteria covering capital adequacy, governance capacity, and demonstrated market need.

Governance reforms within banks should strengthen the role of independent directors, enforce fit-and-proper criteria for board members, and restrict board involvement in credit decisions. Supervisory frameworks should be modernised to incorporate risk-based approaches and real-time monitoring.

Legal and institutional reform is also required. The framework for loan recovery must be strengthened by improving the efficiency of banking tribunals and modernising insolvency laws. Without credible enforcement mechanisms, the cycle of default and restructuring will persist.

Bangladesh has a narrow but real opportunity to implement structural reform. Development partners have signalled their willingness to support such efforts, provided that policy commitments are credible and sustained. Delay will increase fiscal risk, weaken financial intermediation, and constrain long-term economic growth.

A smaller, well-capitalised, and effectively regulated banking system is not simply desirable. It is a precondition for macroeconomic stability. Consolidation, governance reform, and regulatory independence must form the core pillars of that transformation.

Mamun Rashid is a banker and economic analyst.