Transforming Bangladesh's banking sector

In recent years, Bangladesh has experienced significant changes and developments across its financial landscape, but amid the progress, corruption continues to plague the banking sector. The country is at a pivotal moment, as it must tackle systemic issues to ensure a sustainable and robust financial system. Drawing lessons from Japan’s banking crisis and economic collapse in the 1990s, Bangladesh can learn valuable insights to mitigate its current risks.

The revolution, triggered by pervasive corruption and mismanagement, has prompted a thorough restructuring of the banking industry. To restore public trust and ensure the stability of the economy, the government is in the process of implementing reforms aimed at increasing transparency, accountability and efficiency.

Bangladesh is in the early stages of introducing measures to enhance regulatory oversight, boost transparency, and modernise its banking practices. The emphasis on stringent regulation and technological innovation, as seen in the Japanese model, may serve as a guiding framework for Bangladesh’s ongoing efforts.

Recent Banking Challenges in Bangladesh: Bangladesh’s banking sector has expanded its services to include digital banking and financial inclusion initiatives. However, these positive developments are overshadowed by serious underlying challenges. Some of the key challenges are as follows:

Non-Performing Loans (NPLs): The NPL ratio in Bangladesh has been rising steadily, posing significant risks to financial stability. Some economists and aspiring bankers argue that actual NPL is much higher than the published NPL.

Corruption: Corrupt practices, including fraudulent loans, political intervention, weak supervision and overall mismanagement have eroded public trust in the banking system.

Ineffective Regulations: Despite efforts by the Bangladesh Bank to tighten control, regulatory enforcement has been inconsistent, often influenced by political connections manipulated by oligarchs.

If these challenges are not addressed promptly, Bangladesh could face a financial crisis similar to Japan’s in the 1990s.

Japan’s banking crisis in the early 1990s was triggered by a speculative bubble that formed during the late 1980s. Fuelled by loose monetary policies, banks extended excessive credit, particularly in real estate. The collapse of the asset price bubble in 1990 led to a sharp decline in property and stock prices, creating a massive surge in non-performing loans and pushing the economy into a prolonged recession—often referred to as the “Lost Decade.”

Japan’s financial collapse was primarily caused by reckless lending practices, weak regulations, and a delayed response to non-performing loans (NPLs).

Key factors behind Japan’s financial collapse include:

Overextended credit: Banks lent money recklessly to speculative ventures, particularly in real estate, which proved unsustainable when the bubble burst.

Weak regulatory framework: Insufficient oversight allowed banks to continue risky lending practices unchecked.

Delay in addressing NPLs: Japanese banks were slow to recognize bad loans, leading to a build-up of financial problems.

Japan’s experience offers valuable lessons that Bangladesh can adapt to prevent a similar crisis.

Lessons for Bangladesh: To prevent a financial crisis similar to Japan’s, Bangladesh must address NPLs proactively. Banks should be encouraged to write-off or restructure bad loans rather than allowing them to accumulate. Early intervention, coupled with effective recovery mechanisms, can mitigate the risks associated with NPLs and stabilise the banking sector.

Bangladesh must also strengthen its regulatory framework to ensure that banks operate transparently and adhere to sound lending practices. This includes stricter adherence to central bank independence, corporate governance, risk-based lending, technology adoption, Basel III norms, robust stress testing, financial literacy, financial reporting standards, public disclosure, alignment with global standards, and cooperation with international regulators. An independent regulatory body, free from political interference and staffed by ethically sound individuals, is crucial for ensuring the sector’s health.

Japan’s crisis was driven by a real estate bubble, where banks lent excessively against inflated property values. When the bubble burst, these overvalued assets became worthless, leading to massive losses. While Bangladesh has not yet experienced a similar real estate bubble, there are worrying signs of rising property prices, especially in urban areas.

To mitigate risks like asset price bubble in Japan, the country’s banking sector should avoid excessive concentration in any particular sector. Loan-to-value ratios should be closely monitored, and banks should diversify their lending portfolios. Speculative investments must be discouraged, and asset valuations should be based on realistic market conditions rather than speculative growth. Asset revaluations in the banking sector should also be transparent and in line with actual market conditions. Inflating asset values to conceal bad loans only delays the inevitable reckoning and creates greater instability.

Path Forward: The lessons from Japan’s banking crisis offer a clear roadmap for Bangladesh as it seeks to reform its financial system. At the heart of these reforms, there must be a commitment to transparency, accountability, and responsible lending. These include

Independent and Transparent Oversight. Create autonomous and impartial regulatory authorities, composed of individuals with strong ethical principles, to ensure financial discipline throughout the sector. These bodies should be shielded from political interference.

Anti-Corruption Initiatives. Launch targeted campaigns to root out corruption within the banking sector, including independent audits, forensic investigations, and legal reforms to punish offenders.

Balanced Lending Practices. Avoid excessive exposure to any sector, especially speculative ones, and ensure lending decisions are based on thorough risk assessments.

Professionalising Bank Boards: Bank boards should be staffed with individuals who possess strong ethical principles and financial acumen. Minimising political appointments can help prevent conflicts of interest and promote objective decision-making.

Fast-Track Legal Process. One of the reasons NPLs persist is the slow legal process involved in recovering loans. The government should introduce special fast-track courts to handle cases of loan default more efficiently. Speeding up the recovery process would discourage defaults and help banks recover more of their capital. Tightening loss recovery measures and enforcing stricter regulations should be a core focus of banking reforms.

Digital Transformation in Banking. Blockchain technology provides a secure and immutable record-keeping system that can track every stage of the loan process. By integrating blockchain solutions for loan approval, disbursement, and repayment, banks can ensure transparency, verifiability, and reduce the risk of fraud and corruption. Real-time monitoring of loans through FinTech solutions can ensure that banks receive up-to-date information on the financial health of borrowers. Banks should also invest in systems that provide early warning signals for loans that are at risk of becoming non-performing. Such systems can track payment histories and financial changes in borrowers, allowing banks to take preventive actions before defaults occur. Artificial intelligence (AI) is poised to transform the way banks evaluate credit risk. By analysing vast datasets, AI algorithms can provide more accurate predictions of borrower default, leading to improved loan approval decisions and a reduction in non-performing loans (NPLs) over time.

Training Programmes. Banks should offer financial literacy programmes, especially for small business owners and rural borrowers, to help them understand the risks associated with loans and how to manage their finances effectively.

Conclusion: Bangladesh’s banking sector must prioritise reform, combat corruption, and ensure transparency to build a sustainable financial future. The lessons from Japan’s financial crisis serve as a stark reminder that growth without effective governance is a recipe for disaster.

Dr. Syed Md. Aminul Karim is a former member (Grade-I), NBR

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Dr. Md. Ariful Islam is a banker and economic researcher.

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