Banking sector reforms must be based on reality

On February 25, at a discussion titled "Recommendations of the Task Force on Economic Reconstruction" held at BRAC Centre in Mohakhali, Dhaka, Bangladesh Bank Governor Dr. Ahsan H. Mansur addressed the issues plaguing the banking sector and proposed solutions. The event, organized by the Centre for Policy Dialogue (CPD), featured a striking revelation from the Governor: despite efforts to sustain some banks through governance improvements, certain banks are beyond saving due to severe internal mismanagement. The non-performing loan (NPL) ratio for these banks has soared to 87%, with one specific family being held responsible for their downfall. According to him, out of every 100 taka lent, 87 taka was allocated to various projects under this family’s control.

This government-backed family has become a liability to the banking sector. Dr. Mansur also announced that the Bank Resolution Act is being formulated to address banking failures. Some state-owned banks are also struggling, and measures will be taken to prevent the Financial Institutions Division of the Ministry of Finance from interfering in banking operations. The Bangladesh Bank will be allowed to function independently. However, the Governor did not explicitly state what would happen to banks that cannot be saved or how they would be phased out. His remarks, however, indicate that major changes are on the horizon for the banking industry.

The banking sector is often referred to as the lifeline of an economy. If banks fail to perform efficiently, the economy cannot progress towards its desired goals. Since its inception, Bangladesh’s banking sector has been riddled with problems. After independence, all assets were nationalized, including the banking system. This led to widespread mismanagement. Later, a process of denationalization began, transferring banks into private ownership. However, this transition was not without controversy. Some banks were sold at extremely low prices to politically aligned individuals.

During the 1980s, private individuals were allowed to establish new banks, and successive governments issued banking licenses based on political considerations. The worst damage occurred during the last administration when nine private banks were approved, despite opposition from Bangladesh Bank. At the time, then-Finance Minister Abul Maal Abdul Muhith acknowledged that there was no need for new banks but admitted that political pressure led to their approval.

One of the biggest challenges in Bangladesh’s banking sector is its dual regulatory structure. Both Bangladesh Bank and the Financial Institutions Division of the Ministry of Finance share control over the industry. While Bangladesh Bank has significant influence over private banks, it has less control over state-owned banks. The central bank is often required to consider the directives of the Financial Institutions Division before making decisions. This dual control is a major reason for the sector's instability.

During his tenure, former Finance Minister M. Saifur Rahman abolished the Financial Institutions Division, giving Bangladesh Bank sole authority over the banking sector. A similar move could be considered again. Additionally, corrupt and politically affiliated officials within Bangladesh Bank should be identified and removed, replacing them with honest and competent personnel.

Globally, two primary banking models exist: branch banking and unit banking. The United States follows a unit banking system, where banks operate with only a few branches, sometimes as few as three or four. However, unit banking is highly vulnerable—minor economic shocks can lead to bank failures, making the U.S. banking system prone to frequent collapses.

In contrast, the United Kingdom follows a branch banking model, where fewer banks operate but maintain a vast network of branches. This model provides resilience, as individual branch failures do not necessarily jeopardize the entire institution. South Asia, including Bangladesh, inherited the British branch banking system but now operates under a hybrid structure.

India, despite its massive population, has far fewer banks in proportion to its population compared to Bangladesh. The over-saturation of banks in Bangladesh has led to unhealthy market competition, with banks offering similar services and products, often at unsustainable rates. The banking sector has suffered more damage in the past 15 years than in any previous administration.

Recent changes in banking regulations have weakened the sector. Amendments were made to artificially reduce NPL figures, making it easier to restructure loans, write off bad debts, and provide fresh loans to habitual defaulters. Previously, if one project under a business group defaulted, the entire group was considered ineligible for new loans. However, this safeguard has been removed.

According to Bangladesh Bank’s data, by the last quarter of December, total NPLs reached BDT 3.45 trillion, accounting for 20.2% of all disbursed loans. However, the actual figure is estimated to exceed BDT 7 trillion.

There are two types of loan defaulters:

1. Genuine defaulters – Those who, due to unforeseen economic challenges, fail to repay their loans despite their best intentions.

2. Willful defaulters – Those who have the financial capacity to repay but deliberately default to embezzle funds.

The second group poses the greatest threat to the banking system. These individuals maintain close ties with ruling parties, ensuring that no government takes punitive action against them. To tackle willful defaulters:

They should be declared national enemies and boycotted from all state functions.

Their passports should be revoked, preventing them from fleeing the country.

Dr. Mansur has stated that some banks cannot be saved but has not detailed the next steps for these failing institutions. Several measures can be considered:

1. Merging weak banks with stronger ones – A struggling bank can be merged with a healthier institution or be acquired by a more stable bank. Before the previous government left office, there were plans to merge banks, such as integrating Padma Bank with Exim Bank and Bangladesh Development Bank PLC with Sonali Bank PLC. However, the nature of these mergers must be clarified—whether they are actual mergers or acquisitions. A merger forms a new entity, while an acquisition dissolves the weaker bank into a stronger one.

2. Setting performance deadlines for weak banks – Banks that cannot improve within a stipulated period should be shut down.

3. Liquidating non-viable banks – In a free-market economy, businesses must survive on merit. There should be no justification for artificially propping up failing banks.

Currently, 61 banks operate in Bangladesh, which is excessive given the country’s population and economic scale. Authorities do not need to predetermine whether there should be 25 or 30 banks. The market should dictate survival: those unable to compete should exit.

Many internationally recognized banking regulations were diluted under the previous administration, leading to a weakened financial sector. These laws should be reassessed and reinstated where necessary.

Bank employees and future hires must be selected based on competence and unquestionable integrity. A bank is not an ordinary business—90% of its capital comes from public deposits rather than private investment. Even though bank owners hold shares, they do not own all the deposited funds. This distinction must be maintained to safeguard depositor interests.

The banking sector must be free from political influence. Any government in power must refrain from appointing bank executives based on party loyalty. Only a properly regulated and efficiently managed banking sector will enable sustainable economic growth.

M. A. Khalek: Retired Banker & Economic Affairs Writer.