Change of MDs of state-owned banks, when is the policy overhaul?

The Financial Institutions Division under the Ministry of Finance on September 19 issued a circular cancelling the contract-based appointments of Managing Directors and Chief Executive Officers (MDs and CEOs) at six state-owned banks: Sonali, Rupali, Agrani, Janata, BASIC, and BDBL. This unprecedented decision marks the first time in Bangladesh's banking history that so many MD appointments have been revoked simultaneously, sparking intense debate within the sector.

Many employees are now anxious about their job security, fearing that the government might extend similar actions to lower-level officials. The MDs affected by this decision were appointed during the Awami League government and have been accused of being selected for political reasons. Among those whose contracts were cancelled, the MD of BASIC Bank had a tenure of just seven months, while the others had contracts of one year.

The backdrop to this turmoil includes a troubling 32.77 percent rise in defaulted loans across these six state-owned banks. In contrast, privately owned banks account for only 12.56 percent of total defaulted loans in the banking sector. This situation has drawn scrutiny from the International Monetary Fund (IMF), which has mandated that non-performing loans be reduced to 10 percent by 2024 as a condition for a $4.7 billion lending package.

According to the latest reports from Bangladesh Bank, the total amount of defaulted loans in the banking sector exceeds Tk 2.11 lakh crore. However, the figure reported by Bangladesh Bank does not reflect the full extent of non-performing loans (NPLs). When including written-off loans, rescheduled loans, and loans associated with ongoing litigation, the actual amount of defaulted loans could surpass Tk 4.5 lakh crore. Overall, both state-owned and privately owned banks are struggling.

In this context, while the cancellation of MD contracts at state-owned banks and the appointment of new leaders may not raise eyebrows, one must question whether such changes will lead to improved performance. It is uncertain that simply changing the MD will result in better efficiency or effectiveness within the banks.

Moreover, those appointed as MDs during the current interim government may find themselves in a precarious position if a new party takes power after the elections. A leader cannot be expected to perform optimally when their tenure is uncertain. The key question is how much responsibility an MD bears for a bank's success or failure. Changing an MD does not guarantee an overnight improvement in the status of state-owned banks.

Many economists and banking experts argue that the board of directors plays a crucial role in overseeing the MD's activities. If honest and capable individuals are appointed to the board and carry out their responsibilities effectively, banking operations are likely to improve. However, for this to happen, it is essential to adopt correct, realistic, and internationally accepted standards. More importantly, reforming and modernizing existing policies is critical to achieving meaningful progress in the banking sector, rather than merely rotating MDs.

The development of the banking sector hinges more on policy changes than on individual leadership. An MD must operate within established policies, and the Board of Directors is similarly constrained by rules and regulations. Recent legal changes in the banking sector have created significant challenges, and the full impact of these modifications may take 8 to 10 years to fully manifest. Many of these changes, initiated by former Finance Minister AHM Mustafa Kamal, primarily aimed to benefit defaulters and unscrupulous clients. Previous finance ministers, lacking direct business link, did not advocate for such legislative shifts, which have instead focused on protecting business interests.

To restore stability in the banking sector, it is essential to eliminate the dual governance structure currently in place. The sector is effectively overseen by both the Department of Banks and Financial Institutions within the Ministry of Finance and Bangladesh Bank. While Bangladesh Bank holds authority over aspects like the appointment of board members and MDs for state-owned banks, it lacks similar control in private sector banks, leading to inefficiencies. This dual governance is detrimental to both entities.

For meaningful reform and development, the autonomy of Bangladesh Bank must be prioritized, and the Department of Banks and Financial Institutions in the Ministry of Finance should be abolished. The Ministry should not claim to understand the banking sector better than Bangladesh Bank.

In recent years, several legal changes have been introduced that warrant scrutiny. These changes need to be evaluated to assess their long-term implications for the banking sector's health and stability.

Unprecedented unethical opportunities have been extended to several prominent entrepreneurial groups, including the S Alam Group and Beximco Group. These groups benefitted from practices that allowed cheques deposited in their current accounts, even when the accounts held no funds, to be honored without rejection. Subsequently, Bangladesh Bank would replenish the funds to the banks involved. However, this provision was repealed after the interim government took office.

Before leaving office, the previous government enacted legislative changes that further incentivized defaulting loans. Previously, if one project within an entrepreneurial group defaulted, the entire group would be deemed ineligible for additional bank loans. New amendments allowed for exceptions, permitting other projects to continue receiving loans despite defaults. This shift has effectively empowered defaulters within the banking sector.

Additionally, regulations governing directorships in privately owned banks underwent significant changes. Previously, no more than two directors from the same family could serve concurrently, and their terms were limited to two three-year periods. This rule was amended to allow for up to four directors from a single family to hold positions simultaneously, serving up to three consecutive terms. After objections from the IMF, this was adjusted to permit three directors from the same family, thereby opening the door to familial dominance in privately owned banks.

Former Finance Minister AHM Mustafa Kamal also introduced a special provision for rescheduling defaulted loan accounts toward the end of his tenure. Previously, rescheduling required a 10 percent cash down payment of the total defaulted amount. Loan accounts could be rescheduled a maximum of three times, with increasing down payment requirements (10 percent for the first rescheduling, 20 percent for the second, and 30 percent for the third for nine years). The new legal changes, however, allow for a total of ten years for loan rescheduling with a grace period of one year and only a two percent cash down payment required. This creates an avenue for borrowers to reduce their defaulted amounts without fulfilling their loan obligations.

Significant changes have been implemented in writing off loans within the banking sector. Previously, if a loan account was classified as bad for five years, it could be written off by filing a case in court, allowing for a 100% provision to be saved. However, recent amendments now permit the cancellation of a loan account after just two years of being classified as bad, and the requirement for a 100% provision has been eliminated. Furthermore, if the defaulted loan amount is less than Tk 5 lakh, no court action is necessary.

Historically, the laws governing the banking sector adhered to international standards, shaped by recommendations from organizations such as the IMF and the World Bank. Unfortunately, these laws have been altered to favor specific groups, resulting in weakened management practices within the banking sector. None of these legal changes prioritize the interests of regular borrowers; rather, they seem designed to protect defaulters embroiled in legal disputes.

What is particularly striking is the lack of incentives for borrowers who consistently repay their loans. In contrast, banks often extend various benefits to those who default on their installments. For instance, a borrower who takes out a loan of Tk 10 crore and fails to pay for five years may receive interest waivers worth several crores. Conversely, a borrower who diligently repays their Tk 10 crore loan over five years receives no such benefits. This disparity highlights a troubling trend in the banking sector, where the interests of regular borrowers are overlooked in favor of accommodating defaulters.

Defaulters in the banking sector can be categorized into two groups. The first group consists of genuine defaulters—those who, despite their intentions, are unable to pay their loan installments due to various hardships. The second group includes willful defaulters, who take out loans for dishonest purposes, divert the funds to other sectors, or smuggle the money abroad without using it for the intended projects. These individuals are able to repay but choose not to, making them detrimental to the banking sector. To improve the banking environment, strict measures must be taken against willful defaulters. They should face consequences such as being barred from participating in state functions, having their passports canceled, and facing travel restrictions. Enforcing the repayment of defaulted loans can include various methods, such as banning foreign travel.

If the interim government is serious about developing the banking sector, it must take decisive action against these willful defaulters. This should involve confiscating not only mortgaged properties but also all movable and immovable assets of defaulters. Without such measures, the banking sector is unlikely to improve, as the persistent issue of high defaulted loans creates complications like liquidity crises and rising interest rates. Simply changing the MD of a bank will not address the root of these problems.

MA Khaleque: Retired General Manager, Bangladesh Development Bank Plc and Writer on Economic Issues