Changes the banking commission needs to consider

The unprecedented levels of corruption and politicisation in the banking sector over the last 15 years has left the industry in dire conditions. Extraordinary amounts of non-performing loans (NPL) were obtained via bypassing the internal control system of the banks. Gross data anomalies in the accounts of the banks resulted in underreporting the extent of NPL, and significant over-reporting of profits. 

Moreover, bank management were forced to donate huge amounts of funds for supporting the political agenda of the ruling regime in the guise of corporate social responsibility (CSR). Such failures are primarily due to governance-related weaknesses. 

If the proposed banking commission wishes to make meaningful changes of a more tenable nature, we need to focus on making the corporate governance mechanisms of banks more powerful and effective. 

A number of changes in the regulatory and institutional arrangements more specific to the socio-political context of Bangladesh  should be considered.

Curbing family dominance in the board

We need to make sure that the banks are free from the influence of family-based ownership. The current regulations allow three members of the same family to sit in the board of directors of banks. Although this is a welcome reduction from the previous regulations that allowed four members of the same family to hold directorship positions, this still allows family dominance in the board. 

In Bangladesh, limiting directorship to only one family member would be a more effective intervention. The definition of 'family' also requires reconsideration. While the present definition aligns with Western regulations, Bangladesh's socio-cultural context may demand a broader understanding. 

The Bangladesh Bank should exercise discretion in determining whether a non-family member on the board holds strong familial connections.

Composition of the board

The composition of the board is another critical area. A majority of members should be independent directors. While independent directors have long been part of the sector, this practice has rarely functioned as an oversight mechanism. 

Often, independent directors are individuals with close family or business ties to the management, or they lack the necessary expertise. 

The small number of Bangladeshi commercial banks that decided to appoint competent and experienced individuals as independent directors in their boards have benefitted immensely from their expertise and experience.

Thus, the Bangladesh Bank should play a role, possibly through an expert panel, in selecting independent directors. 

Additionally, mandatory short training courses could enhance directors' understanding of their responsibilities. 

The Bangladesh Bank should also oversee the appointment and removal of Chief Financial Officers (CFOs), similar to the approval required for CEOs. At the moment, appointments and removals of the CEOs of commercial banks need to be approved by the central bank. 

Stronger audit committees

Audit committees, too, need reform. 

Currently, The Bank Company Act (1991) requires a maximum of five non-executive directors, including at least two independent directors, to serve on audit committees.

To make the audit committee more effective, all the members of the committee should be independent directors. The Bangladesh Bank should also have their say in the choice of the chair of the audit committee. The audit committee can play a vital role in the selection of the bank's external auditors, and effectively engage in negotiations relating to audit fees. 

There are also questions relating to the process of audit firm rotation, as required by The Bank Company Act. Additionally, the requirement for audit firm rotation every three years is inadequate. This time frame is too short for auditors to fully understand a bank's operations. 

The concept has been introduced following the western countries. However, the rotation period is much longer there, allowing the auditors to gather sufficient experience regarding the nature of the company and its business.

A longer rotation period, similar to the UK's 10-year rule, would improve audit quality, ensuring banks report their financial health more accurately, as it can not only stop banks from offering loans against non-existent collaterals, but also stop underreporting of NPL in the accounts, helping to depict a much fairer picture of the financial health of the banks.

Mandatory sustainability reporting assurance to stop CSR abuse

Mandatory assurance of sustainability reports is crucial to prevent CSR fund misuse. Though the Bangladesh Bank initially championed CSR in the banking sector, it has become a tool for corporate political activities.

As reported in the media (as well as in a number of recent research papers on the banking sector in Bangladesh), commercial banks in Bangladesh were forced to divert CSR funds to projects and programmes that directly benefited the ruling political party. 

Suspiciously, these contributions increased before the 2024 elections. 

Mandatory assurance of sustainability reports of banks would ensure that such donations are in line with the existing CSR guidelines of the Bangladesh Bank. 

Additionally, donations to specific funds, like the Prime Minister's relief fund, should be audited immediately. 

Unfortunately, the mandatory audit requirement was removed in the 2020 Sustainable Finance Policy. Although the Bangladesh Bank had initially introduced the idea of a mandatory audit of sustainability reports, this requirement was removed in its Sustainable Finance Policy issued in 2020. 

The requirement should be brought back without haste. 

The recent student movement presents a unique opportunity to address the institutional weaknesses in our banking sector. Reforms must be pursued, keeping Bangladesh's socio-political context in mind.

Javed Siddiqui is a professor of Auditing and Corporate Governance at the Alliance Manchester Business School, University of Manchester, UK and a member of the Research Advisory Board of the Institute of Chartered Accountants of England and Wales (ICAEW). 

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