Financial Sector Reform in

Bangladesh: Developments and Achievements

March 2005

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Structure of the Banking Industry: 2004

A. Total Deposits (Billion US$)

B. Total Advances (Billion US$)

C. Total Funds under Management (FUM) (A+B)

21

16

37

Number of Banks

Number of Branches

Urban

Rural

49

6303

2579

3724

Capital Adequacy Requirement 9% RWA or US$ 17 million or whichever is larger

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Market Share of Fund Under Management (FUM)

Bank Branches Manpower

  Urban Rural Total  

1990 1900 3685 5585 97345

1995 2242 3610 5852 101311

1998 2349 3622 5971 103852

2001 2502 3680 6182 107456

2004 2579 3724 6303 111641

Number of Banks and NBFIs

NCBs   4

PCBs 30

FCBs 10

DFIs 5

NBFIs   28

Market Share of Fund Under Management

0

10

20

30

40

50

60

70

1990 1995 1998 2001 2002 2003 2004

NCBsPrivate Banks

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Structure of the Banking Industry

NCBs’ role has declined. NCBs’ share in total assets:

down from 54% in 1998 to 37% in 2004.

Private banks’ share: up from 33% in 1998 to 54% in 2004.The remarkable development was due to

increased competition, policy decision to restrict and

strengthen NCBs, Strengthening regulation of

PCBs by BB.    

Share in Assets

  1998 2001 2004

NCBs 53.5 46.6 36.9

Private Banks 32.7 41.9 53.9

Share in Deposit Liabilities

  1998 2001 2004

NCBs 60.6 47.0 42.8

Private Banks 34.4 41.0 51.5

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Capital requirement of banks raised,

Asset quality of the banking system improved, Healthy Return on assets/equity.

Performance

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Capital Adequacy of the Banks

Measures Taken (2002-2003)Measures Taken (2002-2003) Minimum capital requirement on risk-weighted basis was

raised from 8% to 9%; Minimum capital requirement raised from Tk. 40 crores to

Tk. 100 crores ($17 million). OutcomeOutcome

Increased floating of banks’ share in capital market to source capital;

Healthy increase in share prices of banks; Banks’ share in total market capitalization rose from 10%

in June 1998 (PCBs capital adequacy ratio was 9.2%) to 47% in December 2004;

Private banks’ capital adequacy ratio has increased from 11 % in 1998 to 12.2% in 2004.

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Measures Taken during 2002-04Measures Taken during 2002-04 Stringent loan rescheduling conditions

introduced, Limitation on dividend payout

introduced, Strict measures enforced on loan loss

provisioning, Loan write-off guidelines issued Effective use of Credit Information

Bureau, Large loan limitation (single party

exposure) introduced, Total of large loans by banks linked to

bank’s NPL ratio, Money Loan Courts Act revamped in

2003, Corporate Governance measures

substantially enhanced,, Early Warning System introduced.

Non Performing Loans Reduced – All Banks

Outcome (2001-04)Outcome (2001-04)• Gross NPL ratio of banks down from 31.5%to 17.6%• Net NPL ratio of banks down from 16.8% to 9.8%.

NPL Ratio (in percentage): All Banks

0

10

20

30

40

50

1998 1999 2000 2001 2002 2003 2004

Gross

Net

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Gross and Net NPLs – 1998-2004

•Gross and net NPL ratios of all banks improved during 1998-2004;

•Gross NPL: for private banks declined from 28% to 8% during 1998-2004. Net NPL ratio: declined from 16% to less than 3%.

• Gross NPL ratio of NCBs: declined from 40% to 25% and net NPL ratio from 27% to 18% during 1998-2004.

Gross NPL Ratio

  1998 2001 2004

NCBs 40.4 37.0 25.3

Private Banks 27.8 15.1 7.6

All banks 40.6 31.5 17.6

Net NPL Ratio

  1998 2001 2004

NCBs 26.8 25.2 17.6

Private Banks 16.3 4.5 2.7

All banks 23.2 16.8 9.8

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Corporate Governance: Measures taken during 2002-2004

1. Fit and Proper test for CEOs of banks tightened,

2. Fit and Proper test for bank directors introduced,

3. Provision of independent directors representing depositors’ interests,

4. Maximum number of directors for bank reduced to 13,

5. Limiting directorship of banks to six years or two terms,

6. Only one director allowed from each shareholding family,

7. Instructions issued to constitute Audit Committee of each bank’s Board to assist in financial reporting, audit, and internal control,

8. Much enhanced annual financial disclosures required including publication in newspapers and ensuring availability for public view in bank branches,

9. Risk Management Guidelines introduced.

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Risk Management Guidelines

Risk management guidelines on major risk areas covering Credit, Market and Operational risks issued, [Credit, asset-liabilities, foreign exchange, internal control/systems, anti-money laundering];

Prudential Guidelines for Consumers Credit issued,

Prudential Guidelines for Small Business lending issued.

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Supervision and Enforcement Measures

1. Four Managing Directors (CEOs) of banks removed;

2. A number of banks fined for violation of regulations,

3. 65 Bank directors and Chairmen lost their directorships for loan default, insider lending practices and other violations.

4. Guidelines on Early Warning System and Problem Bank introduced,

5. Systems Audit with a risk rating [calculation of standard of a system (viz., core risk areas) of a bank after completion of an inspection] introduced, 50 audits in different risk areas completed so far,

6. Audit and IT security for banks initiated. 25 banks audited so far.

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NCB Resolution Strategy

Goal: Improve Performance and Divest NCBs MOUs between BB and the four NCBs signed, setting a ceiling of

5% on annual growth in lending and a single party exposure to only 5% of paid up capital of each bank.

Rupali. Financial Advisor appointed; began work in June, 2004. Information Memorandum being finalized. Goal: Divest majority ownership to a private sector strategic partner.

Agrani. A firm (PWC) has taken over management in October, 2004. Goal: Restructure, corporatize and bring to a point of divestment.

Janata. A team of external experts being contracted to help manage the bank better. Goal: Restructure, corporatize and bring to a point of divestment.

Sonali. External management advisory team began work in August 2004. Goal: Restructure, corporatize and bring it to point where a minority shareholding can be divested over the medium term.

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Fiscal Policy Provided Cornerstone of Macroeconomic Stability

Financial sector reforms & achievements during the last 3 years occurred in a stable macroeconomic environment;

Macroeconomic stability and improvement in monetary policy framework made possible by prudent fiscal policy;

During the 3-year period, FY02-FY04, government brought down fiscal deficit from over 5 percent of GDP in the previous years to below 4 percent of GDP by raising revenue and streamlining expenditure;

More importantly, increasingly higher share of deficit has been financed from concessional aid leading to a marked decline in domestic financing, allowing private sector credit growth at a healthy rate and reduction in interest rate.

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Monetary Policy Operation – Made More Effective

Daily and weekly Liquidity Forecasting Framework Developed [since 2002];

BB introduced repo [2002] and reverse repo [2003] facility for more effective monetary policy operation – i.e., managing liquidity on a daily basis;

Long-term Treasury Bonds for 5 year and 10 year introduced in 2003 for effective benchmarking of long-term loans;

Electronic registry of bonds (scrip less) introduced in 2003.

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Foreign Exchange Rate Policy and Operation

Taka was floated against all major currencies in June 2003;

BB managed the transition successfully. Move to floating exchange rate regime done without volatility in exchange rate;

To mitigate short-term fluctuations in exchange rate, mechanism for BB intervention in forex and money markets developed;

Banks are allowed to make currency swaps subject to counterparty limits.

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Interest Rate DevelopmentFACTS

• Interest rate was deregulated in early 1990s

• Nominal lending rates remained at high levels until recently.

In 2001 inflation rate was 1.9% and average lending rate 14.4%.

OUTCOMEOUTCOME

• Yield on T-bills reduced

• In Dec. 04 weighted average lending rate of commercial banks declined by about 2 percentage points from the level of FY 03;

•Credit to private sector grew at a healthy double digit rate;

•M2/GDP ratio increased indicating financial deepening.

Recent Measures• Macro stability achieved; strict limit on govt. borrowing from bank;• BB introduced repo and reverse repo for more effective monetary operation;• SLR reduced from 20% to 16%;      • BB publishing rates to promote transparency and competition.

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Financial Market Development

Lending to Specialized Sectors Small Enterprise Fund, a refinance window for SME (at

5% interest rate) created in May, 2004: BB resources (about $17 million); World Bank ($10 million); and ADB ($30 million). $20 million disbursed May 04 – Feb 05.

Refinance window on micro-finance operated by PKSF financed by govt. and donors. Growth over 20% in FY04.

Equity Entrepreneurship Fund, venture capital fund, funded by Govt. & operated by BB created. Disbursement growing fast. About $7 million in FY03 and about $9 million in FY04 and $30 million in FY 05 up to March 2005.

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Financial Market DevelopmentDevelopment of Bond Market: Govt. Bond Market: Bonds of different tenors (5 and 10 years) issued (2003) to

develop yield curve & encourage term lending by setting benchmarks for long-term interest rates.

Securitization: BB, SEC and NBR developed an enabling legal, regulatory framework for bonds/securitization of receivables. Securitization of receivables of private financial institutions started. First ever securitization was completed. Work ongoing on securitization of Jamuna Bridge revenue.

Housing Finance: Initiatives underway to develop long-term housing finance. Key issues being addressed:

transaction costs (property transfer tax, registration, title transfer etc.) tax incentives, availability of long-term funds.

Private commercial banks have begun to move to housing market with longer tenures and lower interest rate.

Development of Inter-bank Market: Inter-bank market for foreign exchange developing fast – following floating of Taka Initiatives underway to further develop inter-bank money market- for effective

intermediation of surplus liquidity in banks.

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BB accounts now fully compliant to International Financial Reporting Standards (IFRS)

International audit firm KPMG and its local affiliate certified that BB financial statement & disclosures for FY2004 have been fully complied with IFRS without any qualifications;

In accordance with the IFRS guidelines, provisions were made against non-performing assets (some bad loans were written off);

A set of reconciliation of inter-branch accounts, and central & subsidiary ledger has been made;

Revaluation of forex account and fixed assets done to comply with the IFRS;

Employee provident fund separated from the Bank’s account; BB is currently implementing a program to strengthen the

Accounting and Budgeting Department by recruiting a Chartered Accountant and training of the staff.

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Strengthening of the BB

Departments restructured; Services standards established for different department

to speed up decision making; Work flow analysis completed for some departments to

reduce unnecessary steps in decision making; Same day clearing service introduced for high value

checks; Clean note campaign initiated – number of soiled/torn

notes in circulation reduced significantly; Direct recruitment through competitive examination

being done on an annual basis; Recruitment for some specialized positions being made

through open competition.

Measures Already Taken

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Strengthening of the BBComponents of Bangladesh Bank Strengthening Program: 1. computerization of operations of BB, 2. human resource development through reforms of recruitment,

promotion and compensation policies, 3. Direct recruitment taking place every year for the past three years,4. Promotion policy being radically changed to emphasize merit,5. restructuring the different departments, 6. reengineering the business processes, 7. capacity building in the core activities8. With enhanced capacity has come better enforcement of laws and

regulations,9. Within Research Department, Policy and Analysis Group being set

up through open advertisement. Agreement with WBI signed.

The goal is to transform the decades-old traditional and manual system to a modern, automated system.

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Challenges Ahead

Broadening access to Middle and Lower Income Groups: By broadening their client base to cover the “missing middle” with new products, banks can diversify their risks and earn higher profits,

Implementation of NCB Resolution Strategy, Introduction of information technology in banking system in an

aggressive manner, Corporate Governance has to improve further. It should be a

continuous process, Financial soundness indicators show an upward trend, but there are

weaknesses and vulnerabilities that will need continued watching, Infrastructure Financing: The investment requirement for

infrastructure development is large. While these investment needs continue to be financed through public investment, there is a need to develop ways to bring in larger private sector financing through the banking system and capital markets.

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Thanks

Thank You