The World Bank in a recent report said bad loans are spiraling in Bangladesh because in most cases politically motivated lending and inadequate credit risk management are adding to spilling bad loans.
"Non-performing loans (NPLs) are rising, triggered by widespread related-party and politically directed lending on the back of weak credit risk management," it said.
The global lender report made the observation based on an information document for a $400 million loan project for Bangladesh, which is still under scrutiny.
NPLs had officially increased by 20.7 percent year-on-year at the end of December 2023 to 9 percent of the loan portfolio in Bangladesh, which however remains significantly understated. State-owned banks account for almost half of the NPLs, it added.
"Growing NPLs and rising cost of funds lower banks' profitability and ability to build additional capital buffers, at a time requirement to distribute dividends even by loss-making banks further depletes banks' reserves and increases risks to depositors and creditors," it added.
The WB said Bangladesh Bank, Insurance Development and Regulatory Authority, Bangladesh Securities and Exchange Commission and Microcredit Regulatory Authority the four regulatory bodies in the financial sector lack operational independence, powers and skills necessary for sound financial sector development.
It said despite recent efforts supported by the World Bank and other international financial institutions, much of the financial sector regulatory framework still needs time to be brought in line with international standards, it said.
The banking sector's risks also triggers because of long-standing poor governance, weak market discipline, and low capital buffers, according to the report.
The reported aggregate banking sector capital adequacy ratio (CAR) at 11.64 percent in December 2023 is too low given the high level of risks in the banking sector.
At least 16 banks lacks capital adequacy as they enjoy special BB waivers for deferred loan loss provisions (LLP) and capital increases, the WB report said.
Besides, the existing framework for intervening in ailing financial institutions is weak, with authorities relying on mergers and recapitalization to deal with failing banks, it said.
In December 2023, the central bank adopted a new Prompt Corrective Action (PCA) framework, supported by WB, but it will not be fully in force until April 1, 2025, it said.
As a way forward, the World Bank said broad-based financial sector reforms are crucial for mobilizing private capital necessary to drive further growth.
"This in turn requires the authorities to address in a timely and orderly manner the persistent financial sector vulnerabilities which distort credit flows and, if left unattended, may lead to large losses to the budget and people's savings."
The WB also said the financial sector safety net and crisis preparedness framework need to be strengthened in the face of rising stability risks.
The deposit insurance system (DIS) for banks and non-bank deposit-taking institutions, established under BB two decades ago, is not fully operational and does not comply with international standards.
It said deposit insurance coverage is low and payout mechanism is undeveloped and was never tested. While BB revoked the licenses of several banks in the past, it did not trigger insured deposits despite a large accumulated DIS fund of nearly $ 1.2 billion as of the end of 2023.
"The crisis response framework remains fragmented, non-transparent, and underdeveloped, including access to lender of last resort, least cost resolution and liquidation tools, use of government funds to bail out domestic…banks, mandate and operations of financial stability committee, and crisis communications framework."
The WB said while the banking sector has shown rapid growth in loans and deposits over the past decade, private sector access to credit is now constrained by tight liquidity in banking sector and rising interest rates.
