Bangladesh 2.0: Getting the Bangladeshi banking sector out of ICU

The Bangladeshi banking sector is like a patient who has suffered multiple heart attacks and is in the Intensive Care Unit (ICU) due to a cumulative 15 years of poor governance and collusion from the deposed government and massive fraudulent loans and money laundering with its direct and implicit blessing. 

The interim government has been prompt in action to nurse the dying banking sector back to life. Dr Ahsan Mansur has been appointed as the governor of Bangladesh Bank. And he is working tirelessly to solve the issues plaguing the sector. Yet many eminent economists and banking sector stakeholders are still concerned. 

The questions on everyone's mind are — Will new Bangladesh Bank Governor Dr Ahsan Mansur be able to revive the patient to a sustainable recovery? Or will we see the patient go into cardiac arrest manifesting itself as catastrophic insolvency of the financial system and a run on the banks? 

In Dr Mansur, we have the best person we could have in the role. Since his appointment, he has moved boldly and at a breakneck speed in starting the reform process. He has changed boards in the problem banks, notably those such as Islami Bank controlled by the S Alam Group, as well as others such as IFIC controlled by former Prime Minister's Private Sector Advisor Salman F Rahman (SFR). 

He has stated repeatedly the need to recover black money taken abroad and also seize assets from S Alam, Salman F Rahman, and others, such as former land minister Saifuzzaman Chowdhury Javed, who controlled the United Commercial Bank (UCB) and reportedly owns 260 properties in London. 

Yet, a number of other issues are still concerning the sector. It comes down to the scale of the problem and the lack of fiscal space or resources to solve it. 

The banking sector reform challenge can be assessed by asking three simple questions: 

1) How big is the non-performing loan (NPL) and fraudulent loan gap in bank balance sheets? 

2) How do we fix it, or where does the money come from?

3) How do we institute the necessary governance reforms to make sure it doesn't happen again? 

This corresponds neatly to the three taskforces announced by the Bangladesh Bank Governor: NPL, Asset Recovery, and Bangladesh Bank Reform.  

Firstly, we need to know how big the problem is—specifically, how large the NPL situation is—and, as a subset of how many fraudulent loans were taken, how much of this money has left the country. 

Reports in the press suggest that S Alam-linked banks alone may account for Tk200,000 croreore ($16.6 billion), but the number keeps changing, unfortunately to the upside. The current Chairman of Islami Bank has suggested that Tk95,000 crore, or more than 50% of its Tk175,000 crore loan portfolio, is attributed to S Alam loans. 

So, is the scale of the problem Tk300,000 crore? Informed estimates from some leading economists suggest that it could be as high as 10% of GDP, which would be around Tk550,000 crore, or $45 billion. 

Therefore, it is of critical importance that a systematic and thorough review of those banks' balance sheets is done with a forensic accounting investigation for us to accurately diagnose the state of the patient. 

Given many years of poor regulation from the central bank and governance within the banks themselves, this is not a straightforward process to execute. The new bank boards of the problem banks have a responsibility to cooperate with the NPL Taskforce to come up with accurate numbers. 

Secondly, the banking sector faces the difficult and complex task of fixing the monstrous problem or filling the gap in bank balance sheets. The NPL and fraudulent loan problem of Tk400,000 crore, or $33 billion, is the assumptive midpoint of the range of estimates I have heard in the past few weeks. 

How is the gap filled? 

Normally, banks handle NPLs by provisioning from their earnings. One leading macroeconomist told me last week that this should be the primary strategy. But this is simply unrealistic given the scale of the problem. 

Let me illustrate with the example of the largest S. Alam Group linked bank and the biggest in the private sector, Islami Bank. If the Tk95,000 crore in fraudulent loans to the group and its associates from Islami Bank is correct, and their 2023 net earnings were Tk635 crore, then it would take more than 140 years of provisioning all their earnings to handle the fraudulent loans to the group.  

The point is self-evident—traditional banking provisioning is wishful thinking. 

What about other sources? Well, on the external side, it is encouraging that the IMF, World Bank, ADB, and others have committed to $10 billion to help solve the banking crisis. 

But this will be disbursed in tranches under stringent conditions and simply would not be enough if the problem is $33 billion. 

Other economists and stakeholders suggest that several of these problem banks should be allowed to fail. But we have to understand what this means. 

Whilst wiping out the shareholders such as S Alam is absolutely the right thing to do, is it equitable or indeed politically viable to force depositors to take haircuts, or less technically, lose some of their savings in those problem banks? 

There is no way this should be allowed. Beyond the abject unfairness to innocent depositors, it would risk causing a run on the banks to acroreoss the whole system as depositors rush to withdraw money from problem banks, quickly snowball into an irreversible contagion effect, and destabilise even healthy banks. 

On the latter point, even a healthy bank with no fraudulent loans or low NPLs has counterparty risk with the weaker banks. So we need to avoid this at all costs. 

Where else can the money come from? 

The central bank can print money in unlimited amounts. But as Dr Mansur said on 13 July at a program hosted by the Economic Reporters Forum (ERF), "Inflation would rise even if printing of money continues to protect the Islamic banks. At the same time, it would not be possible to rein in high inflation if money is overprinted and lent to the government. It is a must to stop printing money in the greater interest of curbing inflation." 

Although inflation has fallen a bit recently, we are still in double digits, and printing Tk2,50,000 crore ($20 billion) of high-powered money would risk initiating a vicious cycle of hyperinflation, exchange rate instability, and the need for sharply higher interest rates. It's a clearly risky strategy.

I suggest that Bangladesh Bank liquidity injection to fill the gap may be sustainable if we have a longer-term plan of finding other sources to fill the gap. Think of it like a temporary bank overdraft. 

Next steps in banking reform

Firstly, we need to establish an Asset Recovery Taskforce or Agency as soon as possible to recover international and domestic black money, as discussed in the previous article in this series, "Bangladesh 2.0: Recovering the loot". 

Though difficult and complex with many different parts that must work together, it is definitely possible to recover $20 billion internationally and domestically if we move decisively to establish the Asset Recovery Agency now. 

Secondly, we need to establish an asset management agency that will manage the NPLs with capital injections. 

We know that the biggest source of NPLs and fraudulent loans beyond the S Alam banks are the state banks. Janata Bank alone lent Tk23,000 crore to Salman F Rahman-linked companies. They need to be put under the regulatory supervision of Bangladesh Bank, not the Financial Institutions Division of the Finance Ministry, in order to have their NPLs and balance sheet restructured and then perhaps consolidated and privatised. 

Suffice to say, other critical banking sector reforms are of the central bank itself. Just changing the governor and deputy governors is not enough. We need greater transparency, accountability, and checks and balances of the primary banking regulator. 

An actionable source for filling the banking gap is privatisation and asset securitisation of government infrastructure. We will discuss this in more detail in a future article.

Finally, the newly reconstructed bank boards should not be allowed to dictate specific loan approvals, a practice unheard of in more developed banking systems. 

An independent Bangladesh Bank and greater accountability and independence of bank management would go a long way to avoid the banking sector crisis we face now. 

I conclude by saying we must help the banking sector recover, rebound, and restore public confidence—we have no choice. But the patient requires radical surgery, bold and innovative thinking, and not the traditional macroeconomic and banking orthodoxy. All the key stakeholders, locally and internationally, agencies and experts should work together to make this happen.
 

Ifty Islam. Sketch: TBS

Ifty Islam is the Chairman of Asian Tiger Capital Partners. Email: ifty.islam@at-capital.com 

Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard.