Banking industry: Converting challenges into opportunities

The banking sector of Bangladesh has been experiencing a torrid time for last three years or so. With increased number of financial scams and classified loans, the industry has come under severe criticism from all quarters. Our banking sector is fraught with inefficiency and malpractices as a result of which key performance indicators of most of the banks are not satisfactory.   
The present state of large financial frauds and high non-performing loans (NPL) of banks calls for close scrutiny of the sector and necessitates taking required measures by identifying the overall challenges being faced.
CHALLENGES FACED BY BANKING INDUSTRY:
* Uncertain and unstable political situation
* Sudden deterioration of credit quality and burden of classified loans
* Transition in RMG sector after deplorable safety scandals
* Faltering investment activities  
* Poor infrastructural facilities ( power and energy crisis) hindering further investment opportunities
* Upward trend of availing foreign currency loans by large corporate group
* Interest spread (Net Interest Margin) is getting lower
* Price fluctuations of commodities in local and international market
* Increasing trend of financial globalization / integration
* Slow recovery of global economic environment
* Adopting rapid technological changes
* Government's initiative to construct Padma bridge from own sources may restrict private sector credit growth
* Unpredictable changes in the legal and regulatory framework   
STEPS TO BE TAKEN UNDER PREVAILING BUSINESS SCENARIO: Effective policy guidelines in consistency with changing economic scenario should be formulated. Most of the banks are not equipped, legally or structurally, to stave off the above challenges.
Exerting more concentration on Core Business: The Bank should give further emphasis on their core business activities. The products, which are remunerative for the banks, should be differentiated from credit and deposit products. The features of those products which are not remunerative must be redesigned. In view of global economic meltdown, some US-based banks have put more emphasis on major products rather than all products together. Large banks like Barclays or even Citigroup have shown success in getting rid of the non-earning or less earning relationships through renewed focus on core business areas.  
Introduction of Internal Rating System: Internal rating system may be introduced to appraise overall performance of the credit customers. The abnormal growth of a business may throw the bank into danger. The credit officer should bear in mind that business growth of a customer during a particular period must be commensurate with existing production capacity.
In the event of financing a single unit under a group of companies, audited financial report of the group should also be taken into consideration in addition to financials of the respective unit, which will enable the credit analyst/officer to compare the total group assets with the liabilities of the group. If it is found from the analysis that the company is highly leveraged, then the customer will be identified as a high risk customer. The biggest risk of high financial leverage arises when a company's ROA does not exceed the interest on the loan, which greatly diminishes a company's ROE and profitability.
Shifting focus from wholesale or corporate to SME and retail business: We need to look beyond wholesale or corporate banking. It has been observed that a large business group is becoming a threat for the banking industry although it was considered more resilient. In the year 2012, 0.24 per cent borrowers got 55 per cent of total loans approved registering a 19 per cent growth in large loans against 9.0 per cent growth in case of general loans. Default rate of large loans was also higher than that of general loans. It may be mentioned that rate of provision for unclassified loans and advances allowed in favour of SME (small and medium enterprises) customers is 0.25 per cent whereas it is 1.0 per cent for corporate / large loans. Therefore, focus should be shifted from large to SME and retail borrowers
Ready your bank for risk: Risk management has already become a part of most banks' everyday business. Every financial institution must take deliberate steps to analyse risks to its deposits and core lending activities, manage those risks and also evaluate its need for contingency capital.
In order to face up to the risk of increasing openness and integration of our financial markets with the global financial system, risk management capacities of all banks need to be upgraded. Banks that take these steps will be best prepared to negotiate the changing economic landscape.
Plan for the worst case scenario: At present, the banking sector is in a perilous situation. In the recent stress tests conducted by the central bank, it has been found that most of the banks have sufficient capital buffer to absorb adverse shocks and still maintain the overall capital adequacy ratio (CAR) above the minimum requirement of 10 per cent of risk weighted asset. But if loans of top three borrowers are adversely classified, 23 banks will fall below the CAR threshold.
It is to be mentioned that under Basel-II, the risk of default of the counterparty is being assessed, but under Basel-III, which is going to be implemented in different phases within 2019, the risk of market-to-market losses due to deterioration of the credit worthiness of counterparty, will also be taken in to consideration in addition to default risk. Additional capital charge will be required to address this type of risk.
Because of the prevailing crisis in the banking industry, the market lost confidence in the solvency and liquidity of many banks. In order to improve the ability to raise the resilience during the period of shocks, banks should assess the impact of different stress conditions.   
Maintaining good corporate governance: Business built on the principles of good corporate governance is more likely to succeed in the long run. Helping to shape an environment conducive to good governance, is important for creating an opportunity for conducting business in a more structured manner. Any empirical analysis will reveal that there is a strong relationship between corporate governance and audited financial strength of a particular financial institution.
It is a proven fact that increasing trend in loan scams in some government-owned banks owes its origin to lack of corporate governance. The quality of the credit portfolio is the most important determinant for assessment of success or failure of a bank and which is in effect largely dependent on good corporate governance.
Maintaining required amount of provision: In order to put the banking sector on a sound footing and strengthen the trend of credit discipline, all banks will have to maintain required amount of provisioning from profit against each category of loans and advances. But most of the banks look for an opportunity for keeping minimum amount of provisioning which leads to a greater risk of insolvency. For the purpose of allowing higher dividend, the banks are not maintaining required amount of provisioning to cover the possibility of losses associated with a downturn of credit quality of the borrowers.
The requirement of capital varies with the degree of risk of an asset. Higher the risk, higher would be the capital requirement. Therefore, if the banks allow higher dividends hiding the actual risk level of assets, it could be a great disaster in the long run, as the profit which is being distributed as dividend was supposed to be utilised towards fulfillment of the requirement of additional capital. So it can be said that in some of the cases banks are allowing dividend from capital rather than from profit. The management of the banks should stay away from such self-destructive decisions.           
Renewed focus on restructuring and recovery of non-performing loans (NPL): At present, the total amount of defaulted loans in the banking sector stands more than Taka 500,000 million, out of which 60 per cent is classified as bad loans, against which bank has to maintain 100 per cent provision. As a result, it turns out be a huge burden for the banks. The bank management should therefore make an all-out effort towards recovery of NPL.
As per statistics of central bank, 2,57,500 cases are pending at Artho Rin Adalat. Due to increasing number of stay orders, banks are unable to speed up their recovery drive. The legal advisors as appointed by the large defaulters are more competent than the panel lawyers of different commercial banks which is why it takes quite a long time in getting judgment from the courts. So, the performance of the panel lawyers should be reviewed periodically.          
During the last five years, an amount of Taka 150,000 million has been written off. To write off loans having 100 per cent provision, is an internationally accepted practice in banking business. Although an all-out effort should be continued to recover the written-off loans, it has been observed that in most cases banks are found reluctant to do so.
A separate "Debt Collection Unit" should be set up for the recovery of written-off loans. In order to expedite the settlement of law suits filed against the written off loans, an agency outside the bank may be engaged.
SUSTAINABLE GROWTH VERSUS SHORT-TERM PROFITABILITY: Our banking sector is getting competitive every day. Quality, speed, efficiency and innovation are the main requirements for the banks to equip themselves to negotiate the challenges of the changing business environment. The bankers should bear in mind that sustainable growth is a better choice than short-term profitability and in order to achieve it we should not compromise with any regulatory requirements and must be compliant in all respects. All the banks should have some clear-cut policy/standard with regard to obtaining collateral and other securities from the borrowers. Because of the existing unhealthy competition among banks, the customers capitalise the opportunity of taking loans without completing standard documentation formalities.
Since all banks are engaged in the same basic banking activities, it is the way of delivery of service that can distinguish one bank from the other. So, the banks should not deviate from the standard regulatory requirements to procure additional business. On the contrary, they should concentrate more on providing better customer service.
As our financial sector has undergone a lot of changes, it is imperative that a fresh guideline be provided covering all aspects of changing business environment in the wake of global economic meltdown. A well-planned set of policy guidelines has become an essential requirement for the banks to respond to the changes and to convert challenges into opportunities. Do we have an alternative?

The writer is Senior Vice President & Head of Foreign Exchange Branch, Prime Bank Limited.

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