From the beginning of the pandemic, banks in Bangladesh were kind enough to lend and reschedule the payment installments yet scored an abysmal record in recovering those funds. To solve this problem, the central bank of Bangladesh has introduced a relaxed loan classification policy but in this economic situation, would relaxing the policy work? Are credit rating agencies and methods being somewhat related to this problem? This opinion piece analyzes the NPL and Credit rating performance of seven listed banks based on the equity size (market capitalization). BRAC Bank and Dutch Bangla Bank are the largest banks, Mercantile Bank, South East, and One Bank are the mid-sized banks, and Standard and AB Bank are the small-cap banks.
As prominent individuals in our society manage to avail the facilities surreptitiously and then they act negligently when it comes to repaying the borrowed amount. First of all, it creates trouble for those who are very regular with repayment because when the number of default borrowers increases it caused a change in policy and regulation. And secondly, it is burdensome for banks to manage minimum liquidity. Again, influential clients tend to be waived a large number of their loans while rescheduling faulty assets. Bangladesh bank waived the maximum amount of loans Tk 28.38 billion last year till September in comparison with 2018 (TK 11.94 billion ) and 2019 (Tk 22.93 billion). Central bank statistics showed that almost half of the total default loans (47%) were incurred by state-run banks and last year, the banks’ non-performing loans were Tk 77.56 billion, from Tk 58.59 billion the year before. It is questionable that after so many bad loans, why bank's credit rating (figure 2) is almost the same no magnificent deviations!
According to Bangladesh bank statistics as of 31st December 2021, the cash credit amount was 13729.54 billion. Total disbursement was BDT 742.6 billion in FY 2020 and recovery of 697.2 billion by all Banks and NBFIs. Private-sector lending in Bangladesh surged in December as demand for loans increase for the trade sector to offset the impact of the coronavirus by running the business in full swing. In recent periods, the overall wheel of the economy including imports and exports has begun to turn directions which is the major reason for escalated credit growth. However, this credit growth might fall after the attack of Omicron.
Furthermore, moving with the analysis for the above-mentioned bank with their NPL ratio, which is used to determine prospective bad debts and an inflated NPL ratio indicates the inefficiency of a bank and its management in dealing with assets. The application of good corporate governance at the bank is imperative to lessen the inefficiency or fraud in the lending process and also it has an impact on NPL (Hasan et al. 2019). When corporate governance practice is weak, it creates poor credit culture and poor management of risk which leads to financial instability.
The figure below shows the NPL ratio, which is the number of nonperforming loans in a bank's loan portfolio to the total amount of outstanding loans the bank carries, was higher in FY2019 than that of FY2020. While the economy was standstill for quite a long time due to the pandemic in 2020, all the NPL ratios increased to some extent. During the second wave of Covid-19 in FY 2021 the number of classified loans started to increase further. For instance, an analysis of the annual report shows that compared with Dutch Bangla Bank, AB bank disbursed BDT 16.6 billion more in FY20 (258.2 billion and 274.8 billion loan amount respectively). Their classified loan was BDT 5.9 billion and 46.2 billion respectively that year. This shows the effectiveness of Dutch Bangla Bank as it managed to recover BDT 23.6 billion more.
Figure 1: NPL Ratios of FY’19 and ‘20
An article in Financial Express found that at the end of the third quarter of 2021, NPL grew to more than one trillion from TK 925 billion. The increasing amount of default loans throughout the FY 2021 is quite worrisome. As many borrowers habitually do not repay the loan timely, it raises the size of default loans and eventually shrinks banks' capacity for lending (Zahid, 2022). Salehuddin Ahmed, former Bangladesh Bank governor advises that a central bank should perform three tasks effectively, which are: validation, verification, and action to control non-performing loans. Moreover, MD & CEO of Mutual Trust Bank, Syed Mahbubr Rahman, mentioned that technology can aid in controlling NPL. With the advancement of technology, it’s easier to reach the public and create awareness so that people are aware of the defaulters. We have to invest in technology, as we all know the future is nothing without technology, (IDLC Monthly Business Review, 2022).
On a micro level, corporate governance plays an important role. A strong governance structure confirms ethical banking practices. Bank's effectiveness is highly dependent on corporate governance and ethical mechanism. As banks deal with fundraising and lending to the public, they are likely to encounter great risks and often fail. In order to deal with the situation, risk management practices based on principles of forethought rather than complying with the least requirements are necessary for banks (Cabraal, 2007). Banks can take some stand to control the NPL. Firstly, the client selection procedure has to be rigorous and ethical. Banks should not pass loans to those clients who have a poor record in the past. Secondly, a common scenario in the banking sector is that the company owners or their family members are seen to be the big shareholders of the bank. As a result, when the company needs a loan, the owner uses his internal connection with the bank. Bank management has to pass the loan on that basis no matter what amount of deposit the bank has currently or what is the borrowers' credit history harming the integrity of the banking system.
Another avenue of exploration in controlling pervasive NPL in Bangladesh banks is looking at performance and authenticity of credit rating agencies. Whenever NPL becomes an issue, everyone points to individual banks but a genuine verification of all the credit rating agencies is essential. Are they checking creditworthiness properly? What are their rating tools and indicators to check creditworthiness? Are the rating agencies following the indicators correctly? Credit rating agencies have a significant role to play in battling NPL. For example, if the credit rating agencies had done their job properly then highly speculative banks or risky banks would have performed better and as a result, non-performing loans would have been reduced proportionately. Credit rating agencies such as S&P and Moody's played an infamous role in the financial crisis of 2008 (Zaidi, 2016) and a financial disaster in Bangladesh's banking sector seems imminent due to the increasing default rate.
Fig 2: Bank's long term credit rating
The above table manifests 7 selected banks' long-term credit ratings. According to the table, all the banks hold higher grades to upper-medium grades in the last five financial years. Whereas it is not hidden how much the economy had suffered due to the pandemic. In these circumstances, it is doubtful that how banks even managed to maintain the situation. There should be more significant changes in credit rating scores in FY2020 compared to past years. Now it is thoughtful how accurate credit rating agencies are! Or are these agencies have enough expertise to rate banks effectively? For instance, AB Bank has allegedly laundered around Tk 16.5 billion to the United Arab Emirates through two shady organizations in the name of investment, according to a Bangladesh Bank probe report, (The Daily Star, 2017). The Daily Star report also mentioned that this is the second instance of money laundering by the AB Bank in the last two years. By analyzing their corporate governance structure, it is found that after the AB scam, their management committee was not significantly changed in 2018. After that in FY’18 AB bank’s NPL ratio increased to 33.07% from 7.09% and 18.28% in FY’19. Now after so many ups and downs their changes in credit rating for 2017, 2018, and 2019 were A1, A+, and A+ respectively.
To conclude, the role of the central bank is vital for all the other banks. Instead of changing policies to support bank performance, policymakers should be evaluating banks based on the criteria, and any policy changes that they make should be for the betterment of the entire sector instead of looking at the bank better only. Secondly, the credit rating agency must take responsibility while assigning a credit rating. From analysis, it looks like ratings are not evidence based as the changes are not meaningful in terms of what is happening in the Bangladesh banking sector (figure 2). Thirdly, banks must ensure corporate governance. Loans must be disbursed based on the client's creditworthiness and this rule should be equal for all clients. The Board of trustees should not be owned by family members only. The presence of an independent director in a board structure is important to oversee the management. Overall, healthy management practices and proper technology usage might lessen the serious issue.
Uddin, A.& Rahman, S. (2017, December 18). AB Bank laundered Tk 165cr to UAE. The Daily Star. Retrieved from https://www.thedailystar.net/frontpage/bb-probe-reveals-ab-bank-scam-1506478
Zahid, S. (2022, March 4). NPL volume: Hard to contain. The Financial Express. Retrieved from https://today.thefinancialexpress.com.bd/public/editorial/npl-volume-hard-to-contain-1646314913
Zaidi, D. (2016) The Indisputable Role of Credit Ratings Agencies in the 2008 Collapse, and Why Nothing Has Changed. Retrieved from https://truthout.org/articles/the-indisputable-role-of-credit-ratings-agencies-in-the-2008-collapse-and-why-nothing-has-changed/
IDLC Monthly Business Review (2022). Retrieved from https://idlc.com/mbr/article.php?id=315
Bangladesh Bank. (2019-2020). Annual Report. Retrieved from https://www.bb.org.bd/pub/annual/anreport/ar1920/index1920.php
Hasan, K., Zayed, N., & Islam, M. (2019). Corporate Governance and Non-Performing Loans: A Study on Commercial Banks in Bangladesh International Journal of Strategic Management & Marketing. Journal of Strategic Management, 1(3):014.
Cabraal, A. (2007). Importance of corporate governance for the banking and financial sector. Bank for International Settlements. Retrieve from https://www.bis.org/review/r070314c.pdf