Perspective of bank 'rents' in three different phases in Bangladesh
Friday, 17 October 2008
Mohammad Habibur Rahman
BANGLADESH shares a common past with India and Pakistan in respect of development of banking business. Bangladesh Bank Order, 1972 was promulgated to create the country's central bank -- Bangladesh Bank -- to take over the assets, liabilities and responsibilities of the erstwhile State Bank of Pakistan. At the same time, the government of Bangladesh (GOB) nationalised six large commercial banks in 1972, most of which were owned by the owners/operators belonging to the then West Pakistan, through Bangladesh Bank Nationalisation Order 1972.
Bank Rents: After the liberation, the government adopted 'financial repression policies' in the early stage of the economy by way of administering interest rates and exchange rates, fixing reserve requirement and undertaking selective credit programmes. At this stage, the broad objective of the financial repression policies was to exercise social control over the scattered resources of a war-damaged economy and to promote targeted agricultural and industrial expansion.
GOB went a step further to increase credits through the expansion of these banks' branches. It also deliberately kept the lending rate low and spread rate high so that both banks and borrowers could enjoy sufficient rents for undertaking financial transactions.
In the early 1980s began the dream run of the private sector that had long been waiting in the wing to emulate their pre-liberation counterparts to get into the lucrative banking business.
First it was the nationalised banks -- Pubali and Uttara -- previously owned by Bangladeshi entrepreneurs. Those two banks were then targeted for reversion to the private sector. Accordingly, a new article, 'in the public interest,' was inserted in the form of Bangladesh Bank Nationalisation (Amendment) Ordinance 1977 to pave the way for entry of private sector into this business.
Then the GOB took the first hesitant step towards privatisation by setting up a finance company under the joint ownership of the government and the private sector, principally with the object of operation outside the country by setting up joint venture enterprises. This company, known as International Finance and Investment Company, was later converted into a full-fledged bank with the name of IFIC Bank Ltd. However, the first of the private commercial banks set up was Arab Bangladesh Bank Ltd. on a joint venture basis in 1981-82. This was followed by three rounds of bank licensing creating the so-called three generations of commercial banks each corresponding the period of rule of three main political parties ( Jatiyo Party, Bangladesh Nationalist Party and Awami League).
As a result of liberal policy of the government, credit flow to the economy increased to Tk 49.952 billion (715.46 per cent) in 1982 as compared to Tk 6.1256 billion in 1972. During this period (1974-1982), the government maintained a 6.88 per cent spread on an average, for ensuring smooth intermediation of funds, although the 'real lending rate' in many cases, plummeted to negative levels. Then in 1983, the government took the initiative to foster competition and efficiency in the banking system by way of allowing private banks to operate in the financial market.
However, though the government introduced private sector banking, it did not liberalise the banking system and continued to practise financial repression policies. This was necessary to ensure robustness of the financial system, until the end of the '80s, as the country then lacked in prudential laws and regulations and was boggled with the problem of inept and inefficient human resources. Thereafter, the government undertook a broad-based financial sector reform programme in 1990 under the name of FSRP (Financial Sector Reform Project) in order to enable to reduce the costs of financial intermediation and to determine the bank rent on the fair play of demand and supply of funds. The government also reduced 'bank rate' and 'interest rate' on government savings certificates' so as to keep the lending and deposit rates at a desired level.
While the financial sector reform programme was aimed at liberalising interest rate policies and narrowing the gap between lending and deposit rates or, let us say, reducing bank rents so as to foster competition and efficiency in financial intermediations, it is observed, unfortunately though, that the lending rates as well as bank rents are high in Bangladesh as compared to those of some other Asian countries
For instance, the average real lending rate in Bangladesh for the seven-year period between 2000 and 2006 was 10.86 per cent, which was higher than that in India (6.33 per cent), Nepal (3.68 per cent), Sri Lanka (4.79 per cent), Thailand (4.24 per cent), Indonesia (7.02 per cent), Malaysia (4.6 per cent), China (4.3 per cent), Korea (3.53 per cent) and the Philippines (4.95 per cent). Similarly, the average real rate of deposit in Bangladesh is observed to be higher (3.71 per cent) as compared to that of India (1.2 per cent), Nepal (0.73 per cent), Sri Lanka (0.65 per cent), Thailand (1.75 per cent), Indonesia (-0.56 per cent), Malaysia (0.06 per cent), China (1.73 per cent), Korea (1.18 per cent) and Philippines (0.85 per cent) during the aforementioned period.
Therefore, a question has arisen about high bank rents. When the government repressed interest rate through the mechanics of financial repression policies, what has influenced the banking system of Bangladesh to have high 'rents' even after liberalising the interest rate. Can we mention that unplanned transition to financial liberalisation may have increased financial intermediation costs by way of increasing uneven competition and inefficiency in allocating credits, thereby compelling and financial intermediaries to set high lending rates as well as high 'rents'? Or, can it be inferred that high bank rents are essential even in an interest rate liberalisation regime in order to increase financial deepening?
Development of the banking system in Bangladesh: The growth and development of the banking system in Bangladesh since its independence can be categorised into three major phases. The period from 1972 to 1982 can be termed as first phase, which was aimed at 'nationalisation, reconstruction and expansion of banks'. The period from 1983 to 1989 can be considered as second phase that focused on 'denationalization and privatisation' while the period from 1990 until now can be viewed as third phase that was aimed at 'financial liberalisation and consolidation'.
First phase: In the first phase, the government exercised full control over the financial resources through the nationalised commercial banks (NCBs) and proceeded to revitalise the economy by way of expanding bank branches and credits to the agriculture and public sector. There was, thus, an unprecedented growth of bank branches and credits during this first phase compared to the situation during the next two phases. For instance, the number of bank branches increased to 4470 (273.74 per cent when compared to the year of 1972) in 1982 from 1196 in 1972 and total credits increased to Tk.45.95 billion in 1982 from Tk. 4.27 billion in 1972. Similarly, total deposits also increased from merely Tk. 5.23 billion in 1972 to Tk.36.71 billion in 1982. On an average, this phase maintained a double digit yearly growth, above 20 per cent for deposits and credits and above 15 per cent for bank branches. It is to be noted that during this phase, the government mainly directed lending to priority sectors and state-owned enterprises, which absorbed around 75 per cent of the total advances. Also, during the early 1970s, the government established three specialised banks like 'Bangladesh Shilpa Bank' and 'Bangladesh Shilpa Rin Sangstha' to finance industrial enterprises and 'Bangladesh Krishi Bank' to finance agriculture sector. Therefore, the first phase of the banking developments are basically attributed to the operations of the nationalised commercial banks (NCBs) with full government control on credits and deposits.
Second phase: The Second phase of the banking system started when government denationalized two nationalised banks, Uttara and Pubali bank, in 1983 and allowed private sector to undertake financial intermediations. During this phase, the government pursued policies to increase private industrial growth by way of disbursing easy credits both from the nationalised and private commercial banks. Of course, the government continued priority sector lending policies and used the big four NCBs to finance state-owned enterprises. In fact, these four big NCBs dominated the banking system of Bangladesh during the second phase of its development both in terms of deposit accumulation and disbursements of credits, although a total number of nine private commercial banks was established during this second phase.
The deposit accumulation and credit disbursement performance have been in the major clusters of banks -- NCBs, private commercial banks (PCBs), foreign commercial banks (FCBs) and specialised banks (SBs) in Bangladesh during these three phases of developments. It has been revealed that NCBs accounted for 86.64 per cent of total deposits (including SBs 92.42 per cent) and 76.96 per cent of total credits (including SBs 95.89 per cent) at the end of first phase (1982) and continued to dominate in the second phase also where NCBs accounted for 64.04 per cent of the total deposits (including SBs 68.48 per cent) and 53.88 per cent of the total credits (including SBs 74.69 per cent) at the end of the year 1989. Although, the dominance of NCBs slowed down in the second phase as compared to the 1st phase because of increasing competition in the banking system, the total credit and deposit growth rate increased to 38.82 per cent and 43.49 per cent respectively in 1984 as compared to 29.56 per cent (credit) and 13.97 per cent (deposit) in 1982 (figure 1). On the whole, the second phase of the banking development was also tailored to the disbursement of credits and accumulation of deposits, not to the control of credits.
It is important to note that the easy credit disbursement policy as well as private banking institutions made a transformation of credit during this phase. For instance, the public to private credit ratio, which was 95 per cent in 1980, reduced to 24 per cent in 1987. Unfortunately, there was no sound project-appraisal system in place to identify viable borrowers and projects during this phase. Also, private banking institutions did not have adequate autonomy to choose borrowers and loans were often directed by the political instructions.
In addition, the incentive system for the banks had its main stress on disbursements rather than recoveries, and the accounting and debt collection systems were inadequate to deal with the problems of loan recovery. In consequence, it became more common for borrowers to default on loans willingly and this created a 'sick industry syndrome' in the mid-1980s. For example, the rate of recovery on agricultural loans was only 27 per cent in the financial year 1986, and the rate on industrial loans was even worse. As a result of this poor show, major donors applied pressure to induce the government and banks to take firmer action to strengthen internal bank management and credit discipline. This compelled government to undertake financial liberalisation policies at the end of 1989.
Third phase: The third phase of the banking development started in 1990s when government took a broad-based financial liberalisation measures in the name of 'Financial Sector Reform Program (FSRP). The FSRP brought a number of developments in the banking system of Bangladesh. This development may be summarized into four broad groups such as: i) screening, ii) monitoring, iii) transparency, and iv) lender's recourse regulations.
In case of screening, 'lending risk analysis manual' was put into operation, directed lending and subsidy to the priority sectors were reduced, interest rates were liberalised, insiders' loan were controlled and banks were asked to use CIB report supplied by Bangladesh Bank.
In case of monitoring, performance-planning system, large loan rescheduling system and supervisory role of the central bank were given emphasis while for ensuring stability and transparency in financial intermediations, minimum capital requirement (Tk. 1.0 billion capital adequacy ratio (8.0 per cent of the risk weighted assets), international accounting standard for the preparation of bank accounts were introduced. Banks were also asked to classify their loans, making provision thereof and not to consider accrued interest on classified loan as their income in order to protect banks from vulnerability. Side by side, Money Loan Court Act and Bankruptcy Act were enacted to improve the loan recovery performance.
Another noticeable development during this period (1990s and early 2000s) was the setting up of a large number of private commercial banks and their degree of involvement in bagging both credits and deposits. For example, while in 1989, NCBs accounted for 64.04 per cent of total deposits and 53.88 per cent of total credits; the same was reduced to 36.25 per cent (deposits) and 30.46 per cent (credits) respectively in 2006. This reflected the dominance of private sector banking under the liberalised regime. The public private ratio of credits also indicates another important development of banking in the third phase. In 2006, the private sector received 95 per cent of total credits, whereas the same proportion, i.e., 95 per cent was received by the public sector in the year 1980.
In addition, the sectoral distribution of credits indicated a major transformation of credits during this third phase. For instance, while in 1975 the industrial sector received highest credits (54.16 per cent), the same was reduced to 27.11 per cent in 1989 and then to 19.86 per cent in 2006. Similarly, the importance of agriculture, forestry and fishing also witnessed a reduction (14.23 per cent and 8.40 per cent respectively in the years, 2000 and 2006) in terms of receiving credits from the banking sector.
However, the construction sector (6.88 per cent in 2006) as well as the trade sector (34.11 per cent) received more attention in the third phase of development in comparison to the first and second phase (1.59 per cent in 1982 to 3.92 per cent in 1989 for construction and 24.01 per cent in 1982 to 30.79 per cent in 1989 for trade). Another important development at this stage can be noted and this related to continuous effort on the part of banks to reduce the non-performing loans (NPLs). For instance, while in 1990 the NPL as a percentage of total loans was 26.09 per cent, the same was reduced to 13.56 per cent in 2006. Therefore, development in the third phase can be attributed to the reduction of government control, adoption of market-based mechanisms and the enforcement of prudential regulations to ensure healthy and effective financial intermediation.
Conclusion: At present, the GOB is putting a greater emphasis than before on retail banking, small and medium enterprises (SMEs) and agricultural finance and rural credits. Very recently, Bangladesh Bank issued a circular directing all the banks including private and foreign ones to disburse loans in the agricultural sector conforming to a specific percentage. This policy will, undoubtedly, play an important role on overall development of the country.
(The writer is Senior Vice President, Jamuna Bank Limited, Gulshan Branch, Dhaka)
BANGLADESH shares a common past with India and Pakistan in respect of development of banking business. Bangladesh Bank Order, 1972 was promulgated to create the country's central bank -- Bangladesh Bank -- to take over the assets, liabilities and responsibilities of the erstwhile State Bank of Pakistan. At the same time, the government of Bangladesh (GOB) nationalised six large commercial banks in 1972, most of which were owned by the owners/operators belonging to the then West Pakistan, through Bangladesh Bank Nationalisation Order 1972.
Bank Rents: After the liberation, the government adopted 'financial repression policies' in the early stage of the economy by way of administering interest rates and exchange rates, fixing reserve requirement and undertaking selective credit programmes. At this stage, the broad objective of the financial repression policies was to exercise social control over the scattered resources of a war-damaged economy and to promote targeted agricultural and industrial expansion.
GOB went a step further to increase credits through the expansion of these banks' branches. It also deliberately kept the lending rate low and spread rate high so that both banks and borrowers could enjoy sufficient rents for undertaking financial transactions.
In the early 1980s began the dream run of the private sector that had long been waiting in the wing to emulate their pre-liberation counterparts to get into the lucrative banking business.
First it was the nationalised banks -- Pubali and Uttara -- previously owned by Bangladeshi entrepreneurs. Those two banks were then targeted for reversion to the private sector. Accordingly, a new article, 'in the public interest,' was inserted in the form of Bangladesh Bank Nationalisation (Amendment) Ordinance 1977 to pave the way for entry of private sector into this business.
Then the GOB took the first hesitant step towards privatisation by setting up a finance company under the joint ownership of the government and the private sector, principally with the object of operation outside the country by setting up joint venture enterprises. This company, known as International Finance and Investment Company, was later converted into a full-fledged bank with the name of IFIC Bank Ltd. However, the first of the private commercial banks set up was Arab Bangladesh Bank Ltd. on a joint venture basis in 1981-82. This was followed by three rounds of bank licensing creating the so-called three generations of commercial banks each corresponding the period of rule of three main political parties ( Jatiyo Party, Bangladesh Nationalist Party and Awami League).
As a result of liberal policy of the government, credit flow to the economy increased to Tk 49.952 billion (715.46 per cent) in 1982 as compared to Tk 6.1256 billion in 1972. During this period (1974-1982), the government maintained a 6.88 per cent spread on an average, for ensuring smooth intermediation of funds, although the 'real lending rate' in many cases, plummeted to negative levels. Then in 1983, the government took the initiative to foster competition and efficiency in the banking system by way of allowing private banks to operate in the financial market.
However, though the government introduced private sector banking, it did not liberalise the banking system and continued to practise financial repression policies. This was necessary to ensure robustness of the financial system, until the end of the '80s, as the country then lacked in prudential laws and regulations and was boggled with the problem of inept and inefficient human resources. Thereafter, the government undertook a broad-based financial sector reform programme in 1990 under the name of FSRP (Financial Sector Reform Project) in order to enable to reduce the costs of financial intermediation and to determine the bank rent on the fair play of demand and supply of funds. The government also reduced 'bank rate' and 'interest rate' on government savings certificates' so as to keep the lending and deposit rates at a desired level.
While the financial sector reform programme was aimed at liberalising interest rate policies and narrowing the gap between lending and deposit rates or, let us say, reducing bank rents so as to foster competition and efficiency in financial intermediations, it is observed, unfortunately though, that the lending rates as well as bank rents are high in Bangladesh as compared to those of some other Asian countries
For instance, the average real lending rate in Bangladesh for the seven-year period between 2000 and 2006 was 10.86 per cent, which was higher than that in India (6.33 per cent), Nepal (3.68 per cent), Sri Lanka (4.79 per cent), Thailand (4.24 per cent), Indonesia (7.02 per cent), Malaysia (4.6 per cent), China (4.3 per cent), Korea (3.53 per cent) and the Philippines (4.95 per cent). Similarly, the average real rate of deposit in Bangladesh is observed to be higher (3.71 per cent) as compared to that of India (1.2 per cent), Nepal (0.73 per cent), Sri Lanka (0.65 per cent), Thailand (1.75 per cent), Indonesia (-0.56 per cent), Malaysia (0.06 per cent), China (1.73 per cent), Korea (1.18 per cent) and Philippines (0.85 per cent) during the aforementioned period.
Therefore, a question has arisen about high bank rents. When the government repressed interest rate through the mechanics of financial repression policies, what has influenced the banking system of Bangladesh to have high 'rents' even after liberalising the interest rate. Can we mention that unplanned transition to financial liberalisation may have increased financial intermediation costs by way of increasing uneven competition and inefficiency in allocating credits, thereby compelling and financial intermediaries to set high lending rates as well as high 'rents'? Or, can it be inferred that high bank rents are essential even in an interest rate liberalisation regime in order to increase financial deepening?
Development of the banking system in Bangladesh: The growth and development of the banking system in Bangladesh since its independence can be categorised into three major phases. The period from 1972 to 1982 can be termed as first phase, which was aimed at 'nationalisation, reconstruction and expansion of banks'. The period from 1983 to 1989 can be considered as second phase that focused on 'denationalization and privatisation' while the period from 1990 until now can be viewed as third phase that was aimed at 'financial liberalisation and consolidation'.
First phase: In the first phase, the government exercised full control over the financial resources through the nationalised commercial banks (NCBs) and proceeded to revitalise the economy by way of expanding bank branches and credits to the agriculture and public sector. There was, thus, an unprecedented growth of bank branches and credits during this first phase compared to the situation during the next two phases. For instance, the number of bank branches increased to 4470 (273.74 per cent when compared to the year of 1972) in 1982 from 1196 in 1972 and total credits increased to Tk.45.95 billion in 1982 from Tk. 4.27 billion in 1972. Similarly, total deposits also increased from merely Tk. 5.23 billion in 1972 to Tk.36.71 billion in 1982. On an average, this phase maintained a double digit yearly growth, above 20 per cent for deposits and credits and above 15 per cent for bank branches. It is to be noted that during this phase, the government mainly directed lending to priority sectors and state-owned enterprises, which absorbed around 75 per cent of the total advances. Also, during the early 1970s, the government established three specialised banks like 'Bangladesh Shilpa Bank' and 'Bangladesh Shilpa Rin Sangstha' to finance industrial enterprises and 'Bangladesh Krishi Bank' to finance agriculture sector. Therefore, the first phase of the banking developments are basically attributed to the operations of the nationalised commercial banks (NCBs) with full government control on credits and deposits.
Second phase: The Second phase of the banking system started when government denationalized two nationalised banks, Uttara and Pubali bank, in 1983 and allowed private sector to undertake financial intermediations. During this phase, the government pursued policies to increase private industrial growth by way of disbursing easy credits both from the nationalised and private commercial banks. Of course, the government continued priority sector lending policies and used the big four NCBs to finance state-owned enterprises. In fact, these four big NCBs dominated the banking system of Bangladesh during the second phase of its development both in terms of deposit accumulation and disbursements of credits, although a total number of nine private commercial banks was established during this second phase.
The deposit accumulation and credit disbursement performance have been in the major clusters of banks -- NCBs, private commercial banks (PCBs), foreign commercial banks (FCBs) and specialised banks (SBs) in Bangladesh during these three phases of developments. It has been revealed that NCBs accounted for 86.64 per cent of total deposits (including SBs 92.42 per cent) and 76.96 per cent of total credits (including SBs 95.89 per cent) at the end of first phase (1982) and continued to dominate in the second phase also where NCBs accounted for 64.04 per cent of the total deposits (including SBs 68.48 per cent) and 53.88 per cent of the total credits (including SBs 74.69 per cent) at the end of the year 1989. Although, the dominance of NCBs slowed down in the second phase as compared to the 1st phase because of increasing competition in the banking system, the total credit and deposit growth rate increased to 38.82 per cent and 43.49 per cent respectively in 1984 as compared to 29.56 per cent (credit) and 13.97 per cent (deposit) in 1982 (figure 1). On the whole, the second phase of the banking development was also tailored to the disbursement of credits and accumulation of deposits, not to the control of credits.
It is important to note that the easy credit disbursement policy as well as private banking institutions made a transformation of credit during this phase. For instance, the public to private credit ratio, which was 95 per cent in 1980, reduced to 24 per cent in 1987. Unfortunately, there was no sound project-appraisal system in place to identify viable borrowers and projects during this phase. Also, private banking institutions did not have adequate autonomy to choose borrowers and loans were often directed by the political instructions.
In addition, the incentive system for the banks had its main stress on disbursements rather than recoveries, and the accounting and debt collection systems were inadequate to deal with the problems of loan recovery. In consequence, it became more common for borrowers to default on loans willingly and this created a 'sick industry syndrome' in the mid-1980s. For example, the rate of recovery on agricultural loans was only 27 per cent in the financial year 1986, and the rate on industrial loans was even worse. As a result of this poor show, major donors applied pressure to induce the government and banks to take firmer action to strengthen internal bank management and credit discipline. This compelled government to undertake financial liberalisation policies at the end of 1989.
Third phase: The third phase of the banking development started in 1990s when government took a broad-based financial liberalisation measures in the name of 'Financial Sector Reform Program (FSRP). The FSRP brought a number of developments in the banking system of Bangladesh. This development may be summarized into four broad groups such as: i) screening, ii) monitoring, iii) transparency, and iv) lender's recourse regulations.
In case of screening, 'lending risk analysis manual' was put into operation, directed lending and subsidy to the priority sectors were reduced, interest rates were liberalised, insiders' loan were controlled and banks were asked to use CIB report supplied by Bangladesh Bank.
In case of monitoring, performance-planning system, large loan rescheduling system and supervisory role of the central bank were given emphasis while for ensuring stability and transparency in financial intermediations, minimum capital requirement (Tk. 1.0 billion capital adequacy ratio (8.0 per cent of the risk weighted assets), international accounting standard for the preparation of bank accounts were introduced. Banks were also asked to classify their loans, making provision thereof and not to consider accrued interest on classified loan as their income in order to protect banks from vulnerability. Side by side, Money Loan Court Act and Bankruptcy Act were enacted to improve the loan recovery performance.
Another noticeable development during this period (1990s and early 2000s) was the setting up of a large number of private commercial banks and their degree of involvement in bagging both credits and deposits. For example, while in 1989, NCBs accounted for 64.04 per cent of total deposits and 53.88 per cent of total credits; the same was reduced to 36.25 per cent (deposits) and 30.46 per cent (credits) respectively in 2006. This reflected the dominance of private sector banking under the liberalised regime. The public private ratio of credits also indicates another important development of banking in the third phase. In 2006, the private sector received 95 per cent of total credits, whereas the same proportion, i.e., 95 per cent was received by the public sector in the year 1980.
In addition, the sectoral distribution of credits indicated a major transformation of credits during this third phase. For instance, while in 1975 the industrial sector received highest credits (54.16 per cent), the same was reduced to 27.11 per cent in 1989 and then to 19.86 per cent in 2006. Similarly, the importance of agriculture, forestry and fishing also witnessed a reduction (14.23 per cent and 8.40 per cent respectively in the years, 2000 and 2006) in terms of receiving credits from the banking sector.
However, the construction sector (6.88 per cent in 2006) as well as the trade sector (34.11 per cent) received more attention in the third phase of development in comparison to the first and second phase (1.59 per cent in 1982 to 3.92 per cent in 1989 for construction and 24.01 per cent in 1982 to 30.79 per cent in 1989 for trade). Another important development at this stage can be noted and this related to continuous effort on the part of banks to reduce the non-performing loans (NPLs). For instance, while in 1990 the NPL as a percentage of total loans was 26.09 per cent, the same was reduced to 13.56 per cent in 2006. Therefore, development in the third phase can be attributed to the reduction of government control, adoption of market-based mechanisms and the enforcement of prudential regulations to ensure healthy and effective financial intermediation.
Conclusion: At present, the GOB is putting a greater emphasis than before on retail banking, small and medium enterprises (SMEs) and agricultural finance and rural credits. Very recently, Bangladesh Bank issued a circular directing all the banks including private and foreign ones to disburse loans in the agricultural sector conforming to a specific percentage. This policy will, undoubtedly, play an important role on overall development of the country.
(The writer is Senior Vice President, Jamuna Bank Limited, Gulshan Branch, Dhaka)