The New Nation - Internet Edition

Dr. Saleh uddin Ahmed

Governor, Bangladesh Bank (Central Bank)

One has to agree that no economy can grow and improve the living standards of its population in the absence of a well functioning and efficient financial sector. Improvement of the financial sector can create a conducive environment to enable the poor and disadvantaged to get the benefits of accelerated growth.

The financial sector of Bangladesh is composed of Bangladesh Bank (BB, the central bank), scheduled banks (or, deposit money banks, DMBs), non-bank financial institutions (NBFIs), insurance companies, micro-finance institutions (MFIs), credit rating agencies and stock exchanges. Direct regulatory and supervisory responsibility over DMBs and NBFIs rest with BB.

As banks dominate the financial sector of Bangladesh like many other developing countries, we would keep our discussion confined to the banking sector. Banks at the early stage of history of Bangladesh were nationalised and gradually assets and liabilities faced mismatches. The banking sector had to finance fiscal deficits and fund the state owned enterprises (SOEs). Political influence eventually became dominant in lending decisions, as all the banks were owned by the government. Loan recovery rate drastically fell. Lack of good governance resulted in rise in non-performing assets.

The central bank of the country had limited tools to manage monetary policy. Central bank often had to take the recourse of so-called moral suasion, supported by other direct tools namely determination of SLR/CRR and administered interest rate policy.

There was a major policy shift in early 1980s when private sectors banks were allowed in the country. The sector embarked upon a Financial Sector Reform Programme in the 1990s which primarily aimed at entrusting additional powers to the central bank by strengthening efficacy of its instruments. Interest rates were liberalised; introducing new bills activated open market operation. Attempts were made to improve governance in the financial sector.

The second phase that begun at the beginning of the present decade was a multifaceted one. Reform initiatives attempted to improve legal aspects, corporate governance, loan recovery, exchange and interest rates management, NCB's functions, risk management and efficiency of the Bangladesh Bank. With a strong legal foothold, we could focus our attention on establishing good governance. Better disclosure and transparency standards have been introduced; fit and proper tests prescribed for bank directors, chief executives and advisors; restriction imposed on the composition of the membership of the board of directors; the roles and functions of the board and management were clarified and redefined. Audit Committees were mandated for all banks with clear guidelines and TORs and Early Warning System (EWS) was introduced. To strengthen the banking operation, minimum capital requirement was raised from Tk. 400 million to Tk. 1000 million and the requirement on risk-weighted basis was also increased. Most recently the capital requirement has been raised from Tk. 1000 million to Tk. 2000 million.

Stringent loan rescheduling conditions were introduced to stop ever greening of loans. An upper limit on a bank's exposure to a particular customer or group was introduced. Strict measures have been laid and enforced on loan loss provisioning. Loan write off guidelines were issued by the Bangladesh Bank, allowing the banks for the first time, to write off 'bad' debts against full provisioning. Large loan limit has been linked to bank's NPL ratio. BB is encouraging syndication of several banks for large loans and has issued guidelines for restructuring such loans.

In The Core Risk Management Guidelines on five major risks has been introduced by BB (credit, foreign exchange, and assets-liabilities risk management, internal control and. compliance and anti-money laundering) laying down policies, processes, procedures and structures that will lead to better governance and improved services.

In the monetary and foreign exchange front we have an exchange rate regime, which is now, market determined. Floating of taka since June 2003 was achieved without encountering undue volatility. Further reform in simplifying and streamlining forex operations and payment system is underway. New financial instruments of varying tenure such as repo and reverse repo and government investment bonds of longer tenor have been introduced. Efforts are underway to develop the government and corporate bond market. BB and the Securities and Exchange Commission (SEC) agreed to allow the government bonds to be traded in the stock exchange. Securitization of receivables of private financial institutions has started.

We have initiated a capacity building programme in the Bangladesh Bank. Service standards have been introduced for work in different departments. Workflow analysis has been initiated to bring in greater speed and ensure quality. The Central Bank Strengthening Project (CBSP) includes (a) computerization of the relations of the Bangladesh Bank, (b) human resource development through reforms of recruitment, promotion and compensation policies, (c) restructuring of the different departments, (d) reengineering the business processes, (e) automation of the Clearing House, (f) capacity building in the core activities i.e. monetary policy, regulation of the financial sector, and research and policy analysis. The goal is to transform the decades-old traditional and manual system to a modern, automated system.

BB has got a Policy Analysis Unit (PAU), which produces various analytical policy briefs and publishes Monetary Policy Review, Financial Sector Review and Bangladesh Bank Quarterly.

Nationalised Commercial Banks (NCBs): Sonali Bank, Janata Bank and Agrani Bank have been corporatised and in corporatised as public limited company. Sale of Rupali Bank to a foreign private entrepreneur is underway. These banks will be more accountable to the central bank.

(b) Specialized Banks (SBs): Public sector banks in charge of agricultural and industrial term lending suffer from poor decision making and low efficiency. In order to make them efficient and financially viable, restructuring of these institutions is necessary otherwise it will hinder the overall financial sector stability and soundness.

Non-Bank Financial Institutions (NBFIs) play a significant role in meeting the diverse financial needs of various sectors of an economy as well as to the deepening of the country's financial system. The activities of NBFIs witnessed an impressive growth during the last five years.

Both banks and NBFls to function as complementary institutions should follow some ethical and technical norms. Banks can go for joint financing under syndication arrangements with leasing companies on any project proposal. Capital market, comprising of debt and equity instruments, can play a key role in economic development by channeling surplus resources to the most productive uses. A notable characteristics of the capital market of Bangladesh is its limited role in funding long term investment as compared to banks and non-bank financial institutions. The capital market is still thin having low level of capitalisation, liquidity and depth; it lacks active trading in fixed income securities (bond and debentures). A number of steps have already been adopted to develop the capital market of Bangladesh. However, there are some urgent issues which include the following.

Insufficiency of disclosure of financial statements, weakness of corporate governance, limited fixed-income securities are among the major factors holding back the development of a vibrant equity market in the country. Successful conversion of NCBs into corporate entities hold the prospect of major new entrants into the stock exchanges in the near future, and even foreign banks may seek listing if encouraged. Other ideas to render the equity market more attractive would include the SOE's and the telecommunication companies to issue equity in an orderly fashion. These initiatives will definitely raise the market capitalisation to a significant extent, which will foster the overall economic growth.

Investment in Bangladesh is highly dependent on bank credit. A major fallout of the excessive dependence on bank credit is the mismatch between the asset and liability sides of bank portfolios. The dependence of business on bank credit for investment increases the systematic risk faced by the banking system. There is also the info rmational asymmetry between the borrower and the lender, which adds to the risks faced by the lender. Indeed the latter asymmetry would be alleviated to an extent were the borrower to seek listing in the stock exchange, which could ordinarily require a greater extent of disclosure than otherwise and this may also allow better decision-making on the part of the banks in dealing with applications for credit.

In Bangladesh, fixed-income securities are still limited in variety and bond market is dominated by short and long term government securities. Corporate bond market is in nascent stage having a shallow debenture market. Invincible, efficient bond markets must encompass a mobile primary market, a fluid secondary market, transparent rules and regulations, a conducive tax system, market rules and awareness, well-functioning settlement and custody systems and a trustworthy rating system. Fixed-income securities market in Bangladesh has experienced a number of changes in recent years. To activate secondary market, Bangladesh Bank started repo and reverse-repo auctions and issued licenses to primary dealers in government securities. On the other hand preferential tax treatment for zero-coupon bonds has been introduced, Central Depository System has been created, and stamp duty on transfer of assets has been eliminated for securitisation. The weekly revaluation based on marking to market for the portion of securities held for trading by the banks has been made compulsory. However, further steps are needed such as developing benchmark yield curve in order to ensure the proper development of the bond market. A recent decision of the government to introduced pre-announced volume based auctions will definitely bring more transparency in the country's money market and avoid mismatch between cash and debt management.

The banking system in Bangladesh is continuously adopting modern and innovative products and services, to make smooth payments and transactions. Foreign Commercial Banks (PCBs) in Bangladesh are playing a pioneer role in introducing modern. financial products and services.

The existing innovative products and services consist of Debit and Credit Card, Automated Teller Machine (ATM), Point of Sales (POS), on-line banking (e-banking), Society for Worldwide Inter-bank Financial Telecommunication (SWIFT), and Reuter. These technologies would upgrade the banking services.

Bangladesh Bank has been implementing the Central Bank Strengthening Project (CBSP) with a view to develop Bangladesh Bank into an effective and modern central bank through strengthening its capacity to play due role as the country's monetary authority as well as regulatory and supervisory authority of the banking sector. The project is working and is expected to be completed by June 2008.

Workers' remittances that played an important role in the economic development of the country over the last few decade, is now more closely linked to financial sector development. The role of formal remittance service system is not limited to boosting foreign exchange reserves and matching current account deficit in the short term. Channeling remittances through banks help deepening the financial system and integrates rural people with the formal system. BB is implementing a project 'Remittance and Payments Partnership (RPP)' with fund from DFID, through which Automated Clearing House (ACH) will be installed and migrants' remittance fund will be speedily handed over to the recipients.

A fair representation of financial position of a bank is required by its stakeholders for making their economic decisions. This is significantly influenced by the accounting standard. In line with international norms, Bangladesh Bank introduced international accounting standards (lAS-30) in the banking sector of Bangladesh in 2000. This requirement has brought transparency in the affairs of bank balance sheet by disclosing many sensitive issues such as volume of bad debts, amount of bad debt provisions, shortfall in provision, earning per share, cash flow position, banking risks including contingencies and future losses, maturity mismatch of asset and liabilities, credit facilities allowed to the bank directors. In order to bring more disclosure in the financial statements of banking companies, BB is continuously updating this requirement from time to time in line with International Accounting and Reporting Standards.

Bangladesh is a major compliant of international agreement on fmancial vigilance. Bangladesh enacted the Prevention of Money Laundering Act 2002, a major legislative development to combat financial terrorism. In order to closely monitor money laundering activities and update legal requirements as per international standard, Bangladesh Bank has set up a separate department namely Anti-Money Laundering Department (AMLD).

A Financial Intelligent Unit (FlU) has been established in the Anti-Money Laundering Department of the Bangladesh Bank. The unit is responsible for receiving, recording, maintaining and analysing Suspicious Transactions Reports (STR) and Cash Transactions Reports (CTR) received from banks and other financial institutions. FlU is mandated with responsibility of maintaining liaison with the concerned international bodies and FlUs of other countries. Bangladesh is a signatory of the UN Convention Against Corruption under which international collaboration is envisaged to combat corruption and money laundering activities.

As in many other developing countries, implementation of Basel II is a challenging issue for banking sector of Bangladesh. Compliance of Basel Core Principles (BCPs) requires providing a solid foundation for the eventual implementation of the New Accord. Recently BB has also carried out a self-assessment of the extent of Compliance of BCPs. The findings show that it is now a largely compliant of Basel principles.

Since the New Accord requires substantial prior risk management practices in the banking sector, BB issued 5(five) separate guidelines on 5(five) core risk areas in banking in 2003. It provides a basic foundation for smooth implementation of the New Accord. The risk areas include credit risk, asset and liability/balance sheet risk, foreign exchange risk, internal control and compliance risk and money laundering risk. Since the Accord is complex and may affect different banks in varying degrees, careful and compatible strategies need to be developed. This deserves inclusion of market participants in the decision making process.

In order to establish good corporate governance in banking, Bangladesh Bank issued several prudential regulations specifying qualification of a Bank Director and a Chief Executive Officer. It also issued directives clarifying authorities and responsibilities of Chairman, Board of Directors, Chief Executive Officer (CEO) and adviser to the bank in respect of overall financial, operational, policy making, and administrative affairs. As a part of good governance in banking, BB requires each bank to form an Audit Committee of their Board. The Committee is responsible for review of the financial reporting process, the system of internal control and management of financial risks, the audit process, monitoring of compliance with banking laws and regulations.

Faster GDP growth consistent with the poverty reduction goals cannot be met unless the extent and quality of financial intermediation in Bangladesh advances significantly. In particular, this would require a more competitive banking and non-bank financial sectors capable of reaching out to all sections of the community, rural and urban, catering to all types of marketable financial services. From the point view of a healthy and egalitarian pattern of economic development which is possible by bringing the poor and asset less (so-called unbanked) people within the fmancial system, the whole approach should be based on calibrated balancing of prudential norms and more genuinely inclusive financial services. The policy strategy that has been initiated and the reform programmes undertaken by Bangladesh would not only help the economy to grow at a faster rate but also pave the way for Bangladesh to become a member of the "middle income group country" by the end of the next decade.

(The views expressional in this article are the author's own and do not reflect there of the Bangladesh Bank)