Industry Trend Analysis - Teetering On The Brink Of A Banking Crisis - MAY 2018


BMI View: We believe that the Bangladesh banking sector is increasingly at risk of a banking crisis due to poor operational practices, rising non-performing loan levels, and weak capital buffers. Sector profitability will likely also decline over the coming months due to higher bad loan provisions, narrowing interest margins and slowing credit growth.

The Bangladesh banking sector appears to be heading towards a crisis as panic withdrawals amid a surge in demand for the government's National Savings Certificates reflect a loss in confidence in the banking sector among depositors. This was sparked by the irregularities uncovered during Bangladesh Bank's (BB) investigation into The Farmer's Bank Limited (TFB) and NRB Commercial Bank (NRBCB) which are the latest examples of the corrupt and poor lending practices which we have been highlighting within the Bangladesh banking sector. Given that asset quality and liquidity have been on a downtrend, while capital buffers are weak across the industry, we believe that more banks will struggle to stay afloat over the coming quarters. Profitability is also likely to decline due to higher loan loss provisioning, narrowing net interest margins, and a deceleration in credit growth.

Government's Resolution Plan Likely To Increase Systemic Risk

To make things worse, the government's move to force TFB to raise capital through a sale of 60.0% of its shares to state-owned commercial banks (SCB) Sonali, Janata, Agrani and Rupali will likely increase systemic risks within the sector due to increased balance sheet interconnectivity. State banks themselves suffer from myriad issues including high levels of non-performing assets on their books and poor management, and the irony is that state-owned banks are in a worse shape, accounting for 54.8% of total NPLs despite only accounting for 27.6% of total industry assets.

According to BB's report, TFB relaxed its lending practices soon after its launch in 2013, resulting in a rise in fraudulent and delinquent loans. This subsequently culminated in the bank defaulting on its liabilities and running into liquidity issues - failing to maintain their cash reserve requirement at BB and unable to fulfil withdrawal requests by depositors, sparking a bank run since November 2017. Evidence of poor management which ultimately led to high levels of fraud were also revealed in the NRBCB investigation report, suggesting that weak operational control is likely a widespread issue.

Rising NPLs In SCBs Driving Up Sector Average
Bangladesh - Banking Sector NPL Ratio, %
BMI, Bangladesh Bank

Worst Is Not Yet Over

In our view, the woes plaguing the Bangladeshi banking sector are far from over. Poor regulatory framework, lax enforcement, and corruption have led to a build-up of subprime loans and distortions in the banking sector and this is likely to continue to weigh on overall financial stability. Non-performing loan (NPL) levels are likely to continue rising in the coming months due to ongoing economic headwinds from the agriculture sector (see "Banking Woes Likely To Persist, December 5 2017). The overall sector wide NPL ratio rose to 10.7% in Q1FY2017/18 from 10.1% in the previous quarter, driven by a surge in NPLs in SCBs which saw its NPL ratio increase to 29.3% from 26.8%, respectively.

Capital Buffers Remain Thin
Bangladesh - Banking Sector Capital To Risk Weighted Assets, %
BMI, Bangladesh Bank

Weak Capitalisation Posing Downside Risks To Stability

The situation is made worse as banks have weak capital buffers. Although the sector-wide capital to risk weighted assets (CRAR) ratio stood at 10.6% at the end of September 2017, modestly higher than the 10.0% regulatory requirement, the ratio for SCBs deteriorated to 5.6% from 7.0% the previous quarter. According to the stress test conducted by BB in September 2017, an increase in NPLs by 3.0% and 15.0% would see 4 and 35 banks, respectively, fail to maintain the minimum required CRAR. The presence of concentration risk within the loan books was also highlighted as if 3 and 7 of the largest borrowers of each bank defaulted, then 21 and 38 banks, respectively, would not meet the minimum CRAR.

It was also reported that in addition to the two fourth generation PCBs which were under investigated by BB, namely, TFB and NRBCB, most of the 33 non-bank financial institutions and 40 private commercial banks (PCB) currently face a liquidity crisis. Indeed, according to official data, the Advance-Deposit ratio (ADR) for PCBs worsened to 89.4% at the end of September 2017 from 88.6% in June, exceeding the regulatory limit of 85.0%.

Sector Profitability To Weaken

We expect profitability of banks to weaken over the coming quarters due to three reasons. Firstly, based on data from BB, SCBs continue to record a shortfall with respect to loan loss provisions as their classified loan book appears to be expanding faster than they are able to provision for. However, they will be forced to make up for the shortfall eventually, resulting in higher provisioning going forward. Secondly, given that National Savings Certificates offer depositors a much higher return, this would likely force banks to increase their deposit rate to attract capital, which would lower net interest margins. Lastly, BB aims to implement Basel III standards by January 2019, which will put pressure on banks to raise capital buffers. This, together with our expectations for BB to tighten its supervision on PCBs lending following TFB scandal, should see credit growth slow over the coming months.

Macroeconomic Forecasts (Bangladesh 2014-2020)
Indicator 2014e 2015e 2016e 2017e 2018f 2019f 2020f
National Sources/BMI
Population, mn 159.41 161.20 162.95 164.67 166.37 168.07 169.78
Nominal GDP, USDbn 173.0 195.2 221.2 247.9 272.6 301.9 337.4
GDP per capita, USD 1,085 1,211 1,357 1,505 1,638 1,796 1,987
Real GDP growth, % y-o-y 6.1 6.6 7.1 7.3 6.8 6.8 6.9
Industrial production, % y-o-y, ave 7.7 8.1 7.3 6.8 6.8 7.5 8.3
Consumer price inflation, % y-o-y, ave 7.4 6.4 5.9 5.4 6.0 6.1 6.1
Consumer price inflation, % y-o-y, eop 7.0 6.3 5.5 5.9 6.1 6.1 6.1
Central bank policy rate, % eop 7.25 7.25 6.75 6.75 6.75 6.75 6.75
Exchange rate BDT/USD, ave 77.55 77.98 78.44 80.96 83.34 84.63 85.90
Exchange rate BDT/USD, eop 77.93 78.25 78.92 82.69 84.00 85.26 86.54
Budget balance, BDTbn -414.8 -554.5 -635.9 -683.1 -810.8 -901.0 -1,001.9
Budget balance, % of GDP -3.1 -3.7 -3.7 -3.5 -3.6 -3.6 -3.5
Goods and services exports, USDbn 32.8 33.8 37.0 37.6 39.6 44.6 50.3
Goods and services imports, USDbn 43.8 44.7 46.1 50.4 53.2 58.9 65.1
Current account balance, USDbn 1.5 2.5 4.3 -1.5 -1.9 -1.2 -0.4
Current account balance, % of GDP 0.9 1.3 1.9 -0.6 -0.7 -0.4 -0.1
Foreign reserves ex gold, USDbn 21.5 25.0 30.1 33.5 36.7 40.2 44.0
Import cover, months 5.9 6.7 7.8 8.0 8.3 8.2 8.1
Total external debt stock, USDbn 35.7 38.7 41.1 41.3 41.6 41.7 41.9
Total external debt stock, % of GDP 20.6 19.8 18.6 16.7 15.2 13.8 12.4
Crude, NGPL & other liquids prod, 000b/d 4.2 4.2 4.2 4.0 3.7 3.5 3.3
Total net oil exports (crude & products), 000b/d -105.2 -108.5 -111.8 -115.6 -104.6 -98.9 -90.3
Dry natural gas production, bcm 23.9 26.9 27.1 27.3 27.1 26.7 26.1
Dry natural gas consumption, bcm 23.9 26.9 27.1 27.3 28.5 32.4 34.6