Over the past decade, Bangladesh economy enjoyed favourable economic environment and grew at approximately 6.0 per cent with tolerable inflation. Major economic indicators like gross domestic product (GDP), exports and imports have tripled in the last ten years; industrialisation and trade have soared to unprecedented heights. Growth in the "real" economy has fuelled the growth of the country's banking sector which has seen an increase in deposits by over 400 per cent and assets by around 500 per cent in the last ten years. Simultaneously, per capita GDP has more than doubled and yet more than half the population is still unbanked.
The central bank's decision to allow licenses to nine new banks is not without merit. Regardless of political motivations, a logical argument can be made beyond the unbanked population argument -- that more competition will improve service quality and ultimately benefit the consumers. From the sponsors' standpoint, beyond the ego factor of sponsoring a bank, a logical argument can be made about the potential economic benefit for the sponsors based upon past record, which is estimated to be 25 per cent+ over 10 years from inception of a bank, approximately 15 per cent higher than the risk-free rate in Bangladesh.
PAST PERFORMANCE DO NOT GUARANTEE FUTURE RETURNS: This is all-sounds-great in theory but the ground reality is different and challenges faced by the management and shareholders of new banks cannot be minimised. Banking industry is already highly competitive with many well-established local and international banks having a firm grip on the target market. Therefore, unless these new banks get their act together fast, shareholders could suffer a major set back and even worse some could face extinction.
SHOW ME THE MONEY: Let us refresh our memory about how banks make profit. Banks make money by primarily three ways. First, earning a spread between the deposit rate and the lending rate. Second, fee income from various products and services, and the third, from proprietary investments. This is obviously overly simplified. However, all these modes of earning potential is possible to some extent provided the demand is growing, banks are well-capitalised and have the proper human resource and the rest happens automatically. So what are the challenges?
IT IS ALL ABOUT PEOPLE: At present the banking sector is suffering from an acute shortage of skilled and adept professionals which significantly dent operational efficiency, prospects for long-term growth and not to mention corporate governance challenges. Beyond a few foreign and local banks, unfortunately the quality of staff beyond the Chief Executive Officer (CEO), Managing Director and Deputy Managing Director (DMD) levels the quality drops drastically. Depth and breadth of knowledge unfortunately are poor. This is an ominous sign for the industry since professional human resource is essential for the growth and development of the industry let alone the shareholder's interests. There are weaknesses at every level of the banking industry starting from leadership to product development, operations, and risk management. These weaknesses obviously facilitate frauds, mismanagement, and value destruction for shareholders and encourage and breed substandard corporate governance culture in the financial sector.
The first challenge for the new banks will be attracting the right leadership and support teams from a shrinking pool of candidates. It will not be easy to attract talents for a newly established entity. The most likely outcomes are: either you end up recruiting an unqualified team due to budget constraints or you end up paying a significant premium for talents. Compromising on recruiting professionals probably would be the biggest mistake the sponsors can make in the current competitive market. If you recruit weak managers, then they end up attracting even weaker subordinates and we all know how that works.
ATTRACTING DEPOSITS: While, most banks offer similar commodity type products, they are combating with each other in most cases on price/yield, realistically, the new entrants can gain an initial advantage and capture market share by offering higher deposit rates. Falling deposit rates at present driven by recent political uncertainty, risk averseness, lack of demand for loans and recent spike in demand for short-term government securities provide a lower rate environment. But this provides no relative advantage to the new banks. Therefore, needless to say, attracting deposits will be a great challenge and only offering higher rates and better service may facilitate deposit growth of the new banks.
LENDING TO THE RIGHT CLIENTS: Contrary to popular belief that aggressive marketing, or in this case aggressive lending, may help quickly capture market share and drive banks' profitability, in reality the long-run success of these new banks depends on ensuring that they lend to the right clients. Most of us are aware of the result of aggressive growth in the lending portfolios. As a lender, you only get the stated interest and the principal within the maturity date at best and you have no upside like equity investors. This is why one must wonder why many banks even today lend to entities with no real capital or a sliver of capital created from revaluation and other financial engineering. If the new banks fall into this temptation this could be the first nail in the coffin. Chasing yield and risking principal are the fastest ways to go bankrupt. Therefore, logically to attract strong credit worthy corporations, the new banks will be under pressure to attract by offering lower borrowing rates again compressing the margins/spreads further.
TAPPING THE UNTAPPED: With around half the population unbanked, the biggest opportunity for new banks exists for targeting unbanked rural populations offering them the right products and services. Opening cost-efficient branches and nimble service centres in suburban and rural areas can substantially boost asset size and simultaneously, bring the much-needed diversification that every lender requires to spread out its risk. However, bricks and mortar are expensive and expansion initiatives must be done after due diligence and return on risk capital considerations.
LAST MOVER ADVANTAGE: Despite the challenges, new banks have some vantage points comparing to the existing banks. Currently the industry maintains non-performing loans (NPL) of 8.93 per cent+ which is similar to the levels back in 2007. While all the other government and private commercial banks have been working hard to clean their books, new banks have the luxury to formulate carefully thought-out strategies for market penetration. It is a well-established fact that many of the existing players are required to recapitalisation to maintain minimum capital adequacy. It is a daunting challenge to concentrate both on business expansion and recapitalisation effectively. Moreover, it is more likely that banks will become cautious in further lending that can be an opportunity for new entrants -- a definite blessing in disguise. For past ten years - in the backdrop of consistent economic growth driven by export and remittance, balance sheets of banks have inflated due to aggressive lending, stock market and real-estate bubble and finally, the head-wind -- the sector is now facing serious challenges due to poor balance sheet - all these incidents provide a road map of do's and don'ts for a new bank.
EMBRACING NEW TECHNOLOGY: The biggest advantage for a new bank is the opportunity to embrace technologies to get an edge over the existing players. We expect disruptive technologies to impact banking globally and also to some extent in Bangladesh. For instance, the growth and advancement of mobile technology now provide the plumbing for delivering products and services unthinkable even a few years back. In Bangladesh, more than 70 per cent of the population lives in rural areas, where financial services are generally inaccessible. Furthermore, with the advent of 3G technology in Bangladesh, internet penetration promises to grow exponentially in the coming years. Lessons can be learnt from organisations such as bKash, which has proven how financial services can be delivered conveniently and at a low cost. We believe this is just the beginning and more game changing technologies are expected. Essentially, incorporating technology in disseminating financial services, will allow these entities to tap into the core as well as the periphery of the market. Â
A proponent of free market would think that, increased supply of banks is generally good for the consumers. However, the road to success is not smooth at all - and is expected to be even more challenging in the future. It is not an option but essential to invest in intellectual capital, attracting deposits at competitive rates, focusing on unbanked population, selecting right clients, learning from past mistakes, embracing new technologies and most importantly, developing effective leadership. How well these new banks execute on these dimensions will finally determine their fate in the future.
The writer is Managing                        Partner - LR Global.
Challenges for the new banks
Reaz Islam | Published: April 09, 2014 00:00:00 | Updated: November 30, 2024 06:01:00
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