No bank rated ‘strong’
Industry Report: The banking sector of Bangladesh experienced a moderate level of resilience in FY2018-19. Bangladesh Bank persistently continues its efforts to uplift and ensures a sound and stable performance in the banking sector. In FY18, Bangladesh Bank (BB) adopted a number of policy measures to emphasize risk management and corporate governance in the banks, periodic review of stability of the individual bank as well as the whole banking system, monitoring of large borrowers, fraud-forgeries and strengthening internal control and compliance through self assessment of anti-fraud internal controls etc.
Monitoring of investment in shares by the scheduled banks has been made stringent in light of the amendment brought in the Bank Company Act, 1991 (amended up to 2018). Risk Management Committee at the board level has been made mandatory, with regular evaluation. A revised Risk Management Guideline has already been put into effect for banks to improve resiliency.
Besides, all core risks management guidelines have been revised recently for timely identification, measurement, control, and monitoring of all existing and probable risks of banks.
Banking Sector Performance
The banking sector in Bangladesh comprises four categories of scheduled banks- state-owned commercial banks (SCBs), state-owned development financial institutions (DFIs), private commercial banks (PCBs) and foreign commercial banks (FCBs). Total number of 57 banks operated in 2018. The number of bank branches increased at the end of December 2018 to 9955 from 9654 of December 2017. In 2018, the SCBs held 25.88 percent share of the total assets which was 27.61 in 2017. PCBs’ share in the total assets increased from 65.03 percent in 2017 to 67.07 percent in 2018. The FCBs held 4.62 percent share in the total assets in 2018, showing a decline of 0.18 percentage points over the previous year. The DFIs’ share in the total assets declined to 2.43 percent in 2018 from 2.58 percent in 2017.
Total deposits of the banks in 2018 rose to Tk 9874.89 billion from Tk 8933.92 billion in 2017, showing an increase of 10.53 percent. The SCBs’ share in deposits decreased from 28.38 percent in 2017 to 27.35 percent in 2018. PCBs’ deposits in 2017 amounted to Tk 6508.19 billion or 65.91 percent in the total deposit compared to Tk 5788.02 billion or 64.79 percent in 2017. FCBs’ deposits in 2018 slightly increased by Tk 31.65 billion over the year 2017, although its contribution to total deposits decreased slightly. The DFIs’ deposits in 2018 was Tk 273.32 billion against Tk 249.4 billion in 2017, showing an increase of 9.59 percent over the year.
Aggregate Balance Sheet
Total industry assets in 2018 showed an increase of 12.34 percent over 2017. During this period, the SCBs’ assets rose by 5.29 percent and that of the PCBs’ increased by 15.85 percent. In 2018, loans and advances of Tk 8050.85 billion constituted the most significant portion (61.6 percent) in the sector’s aggregate assets of Tk 13059.26 billion. Moreover, cash in tills including foreign currencies was Tk 117.62 billion; deposits with BB was Tk 810.37 billion; other assets was Tk 2357.83 billion and investment in government bills & bonds was Tk 1722.59 billion during the same period. Deposits continued to be the main sources of funds of the banking industry and constituted 75.3 percent (Tk 9834.19 billion) of total liability in 2018. Capital and reserves of the banks were Tk 910.31 billion (7.49 percent) in 2018 as compared to Tk 859.11 billion (7.40 percent) in 2018.The development of a sound banking sector is important for the sustainable development of an economy. Since banking sector is the main component of the overall financial system in Bangladesh, the health of the economy is closely related to the soundness of its banking system. BB has adopted many prudential policies for maintaining stability in the banking sector. The aggregate micro-prudential soundness indicators (Capital Adequacy, Asset Quality, Management, Earnings, Liquidity and Sensitivity to Market Risk) of the banking sector also known as Financial Stability Indicators are consider for measuring banking sector performance.
Capital adequacy focuses on the total position of banks’ capital and the protection of depositors and other creditors from the potential losses that a bank might incur. It helps absorbing all possible financial risks related to credit, market, operation, interest rate, liquidity, reputation, settlement, strategy, environment & climate change etc. Under Basel-III, banks in Bangladesh are instructed to maintain the Minimum Capital Requirement (MCR) at 10.0 percent of the Risk Weighted Assets (RWA) or Tk 4.0 billion as capital, whichever is higher. Under the Supervisory Review Process (SRP), banks are directed to maintain a level of “adequate” capital which is higher than the minimum required capital and sufficient to cover for all possible risks in their business. This higher level of capital for the banks is usually determined and finalized through SRP and SREP (Supervisory Review Evaluation Process, the central bank’s assessment) dialogue. The aggregate amount of capital of the banking sector was Tk 280.58 billion as on December 2009 which increased to Tk 945.61 billion at the end of December 2018. It is observed that on 31 December 2018, SCBs, DFIs, PCBs and FCBs maintained CRAR of 5.04, -35.45, 12.52 and 24.90 percent respectively. But individually, 4 SCBs, 3 PCBs and 2 DFIs could not maintain the minimum required CRAR. The CRAR of the banking industry as a whole was 10.83 percent at end of December 2018 as against 10.80 percent at the end of 2017. The CRAR of the industry was 10.0 percent at the end of June 2018.
Loans and advances (61.6%) are the major components in the asset composition of all commercial banks. The high concentration of loans and advances increases the vulnerability of assets to credit risk. However, investment of banks in bills, bonds, shares etc. also demonstrates somewhat concentration, which is 13.2 percent to total assets in 2018.
The most important indicator to demonstrate the asset quality in the loan portfolio is the ratio of gross Non-Performing Loans (NPLs) to total loans and net NPLs to net total loans. At the end of December 2018, the gross NPL of the banking sector stood at 9.31 percent. PCBs had the lowest and SCBs had the highest gross NPLs. PCBs’ gross NPLs was 4.87 percent, whereas those of SCBs, FCBs and DFIs were 26.52, 7.04 and 23.39 percent respectively at the end of December 2018. The ratio of gross NPLs to total loans indicates a mixed trend in the banking system.
It declined in 2011 and increased in 2012 (10.0 percent) and again declined in 2013 (8.9 percent). Afterward, the ratio jumped in 2014 (9.7 percent) and again declined in 2015 (8.8 percent). But the ratio shows an upward trend in recent years mainly due to increase in total classified loans, defaulted outstanding and non-recovery of loans. At the end of June 2018, it stood at 10.41 percent.
The high level of NPLs in SCBs and DFIs continued due to substantial loans disbursed by them was on considerations other than commercial criteria. Poor assessment and inadequate follow-up and supervision of the loans disbursed by the SCBs and DFIs eventually consequence the current situation of poor quality assets. However, BB took various measures (i.e. loan classification, loan rescheduling, provisioning and write-off) to recovery the loan. Besides, BB has also taken steps with regard to internal restructuring of these banks to strengthen their loan recovery mechanism and write-off measures in recent years.
The ratio of net NPLs (net of provisions and interest suspense) to net total loans (net of provisions and interest suspense) was 2.2 percent in 2018 for the banking sector and it was 11.2 percent for SCBs. SCBs’ and PCBs’ non-performing portfolios increased in 2018 as compared to that of the previous year. The net NPLs were 11.2, 9.7, 0.2 and 0.7 percent for the SCBs, DFIs, PCBs and FCBs respectively at the end of December 2018. Net NPL of the industry was 2.7 percent at the end of June 2018.
The amount of NPLs of the four types of banks since 2010 to 2017. The amount of NPLs of the SCBs increased from Tk 127.6 billion in 2008 to Tk 373.3 billion in 2018. The amount of NPLs of the PCBs stood at Tk 294.0 billion in 2017 up from Tk 64.3 billion in 2010. The amount of NPLs of the DFIs increased to Tk 54.3 billion in 2018 from Tk 37.3 billion in 2008. The amount of NPLs of the FCBs increased to Tk 21.5 billion in 2017 as against Tk 5.5 billion in 2010. The total NPLs of the banking sector have increased to Tk 743.0 billion in 2018 as compared to Tk 621.8 billion in 2017 and the amount of NPLs has increased in SCBs and PCBs and has decreased in DFIs and FCBs in 2018 as compared to that of the previous year.
The amount of NPLs of SCBs, DFIs, PCBs and FCBs stood at Tk 428.5, 52.4, 389.8 and 22.7 billion respectively at the end of June 2018.
The aggregate amount of NPLs, the required loan loss provision and the actual provision maintained by the banks from 2010 to 2017. The banks continuously failed to maintain the required level of provision against their NPLs from 2010 to 2018. Banks maintained 103.0 percent in 2011. But in the recent years the provision maintenance ratio showed declining trend and in 2018 it stood at 84.7 percent.
The main reason for the shortfall in provision was the inability of some SCBs and PCBs, including those in the problem bank category due to increase in classified loans, poor quality and inadequacy of collaterals, low profit and provision transfer for write-offs. On the other hand, the FCBs were in a much better position since they were able to keep adequate provisions.
In order to rectify an unnecessarily and artificially inflated size of the balance sheet, a uniform guideline for write-off was introduced in 2003. Banks may write off bad/loss loans complying with the conditions covered by the guideline.
Out of 40 PCBs 35 were able to maintain the required provision at the end of December 2018, but the remaining five banks failed due to their poor asset portfolios and earning levels. The provision maintenance ratios of PCBs and FCBs show its increasing trend, whereas that of SCBs and DFIs show the declining trend in the recent years.
Sound management is the most important pre-requisite for the strength and growth of any financial institution. The total expenditure to total income, operating expenses to total expenses, earnings and operating expenses per employee and interest rate spread are generally used to determine management soundness. Technical competence and leadership of mid and senior level management, compliance with banking laws and regulations, adequacy, compliance of sound internal policies, ability to plan and respond to consideration to illustrate the quality of management. The expenditure-income (EI) ratio of the DFIs was the highest among the bank categories in 2018 which was mainly attributable to poor non-interest income and higher operating expenses. However, it decreased from 137.8 percent in 2017 to 124 percent in 2018. The EI ratio of the SCBs was 81.3 percent in 2018, the second highest, which could mainly be attributable to high administrative and operating expenses. In 2018, the EI ratio of PCBs and FCBs was 73.78 percent and 46.55 percent respectively, which slightly increased as compared to the previous year.
At the end of June 2019, the EI ratio of SCBs and DFIs stood at 83.9 and 149.9 percent respectively whereas those of PCBs and FCBs stood at 78.4 and 44.3 percent respectively.
Earnings and Profitability
Although there are various indicators of earnings and profitability, the most representative and widely used one is return on assets (ROA), which is supplemented by return on equity (ROE) and net interest margin (NIM).
Earnings as measured by ROA and ROE differ within the banking industry. Analysis of these indicators reveals that the ROA of the SCBs and DFIs was less than the industry average. The ROA of SCBs has improved slightly in 2018. PCBs’ ROA shows a declining trend during 2011-2012 due to decreased net profit. After 2012 it shows a fluctuating trend. Though FCBs’ ROA showed a decreasing trend from 2014, it still remains in strong position.
ROE of the SCBs stood at 3.45 percent in 2018. It has improved as compared to 2017. ROE of DFIs is negative 3.07 percent. Though it has improved from 2017 and it has always been negative in the previous years. ROE of PCBs is 12.01 percent in 2018 and it shows an increasing trend since 2013. ROE of FCBs has been declined since 2014 and it was 11.31 percent in 2018. Net Interest Margin (NIM) of the banking industry stood at 3.13 percent in 2018 which was 3.27 percent in 2017. The NIM for the SCBs and DFIs inched up where as PCBs and FCBs inched down slightly in 2018 compared to 2017. Analysis of the indicator reveals that NIM for PCB and FCBs were higher than the industry average. NIM for SCBs was negative in 2013, afterwards it showed a mixed trend during 2014-2017. At the end of June 2018, NIM of industry was 3.18 percent.
Maintaining a sound liquidity position is one of the significant indicators of bank’s solvency. Without ensuring adequate liquidity the banking sector will fail to mobilize its resources for earnings profit and they maintain adequate liquidity for ensuring safety and security. The most useful indicators for evaluating the liquidity position in the banking sector are advance-deposit ratio (ADR), interbank call money rate, repo rates, liquidity coverage ratio (LCR) and net stable funding ratio (NSFR).
Overall advance deposit ratio (ADR) in the banking system moderated to 76.7 percent in Q4FY18 from 77.0 percent in Q3FY18, remaining below the maximum regulatory ceiling1. Banking sector maintained the LCR much above the minimum requirement of 100 percent throughout FY18, indicating banks had high-quality and liquid asset that would cover the banks cash outflows for a minimum of 30 days. In FY18, banks also maintained the minimum regulatory requirement of holding NSFR that indicates they had enough funding for the whole year in any unfavourable situation.
The FCBs have the highest liquidity ratios followed by the SCBs. There is an overall steady trend in the ratio of liquid assets to total assets of the banks during the last few years although the ratio for DFIs is zero as they do not need to maintain SLR.
On the other hand, the scheduled commercial banks have to maintain a CRR (cash reserve ratio) averaging 5.5 percent daily on a biweekly basis against average total demand and time liabilities (ATDTL) of the second preceding month, with an obligation to maintain daily minimum 5.0 percent cash against the same ATDTL held by the bank. The current rate of SLR (statutory liquidity reserve) for conventional banks is 13.0 percent of ATDTL. In case of Islamic Shariah based commercial banks, the rate of SLR is 5.5 percent of their ATDTL. Three banks (two specialized banks and BDBL) are exempted from maintenance of SLR, but they have to maintain the CRR at the stated rate. The banks maintain CRR in cash with Bangladesh Bank. However, they are allowed to hold government approved securities (unencumbered portion) for maintenance of the SLR.
Banking sector faced liquidity tightening in 2018
As liquidity condition tightened, BB reduced Cash Reserve Ratio (CRR) by 100 basis points to 5.5 percent and repo rates by 75 basis points to 6.0 percent with effect from April 2019. This will give banks and financial institutions a scope to recalibrate their liquidity position in case of adverse situation. BB’s policy measures led to improvements in liquidity conditions as reflected in the call money rate which came down from 4.56 percent in March to 3.41 percent in June 2018.
CAMELS rating is a supervisory tool to assess and review the financial soundness of the banking companies. It helps BB to remain always vigilant over the banks and identify those banking companies, which have problems and require close supervision. The previous CAMELS rating guideline has been reviewed by the Department of Off-site Supervision with a view to assessing the banks’ soundness more accurately, reflecting the banks’ financial condition and management issues more pragmatically, making the guideline more country perspective oriented and making an effort to address good governance issues in the banking sector. The revised CAMELS rating guideline came into effect from 2013. A partial revision has been brought into the guidelines latest in 2016.
The revised CAMELS rating guideline has brought not only major changes in ratios or indicators but also modifications in the questionnaire for evaluation of qualitative issues. Basel-III principles related to capital adequacy have also been reflected in the guideline. Along with emphasizing best quality capital, investments in the capital market, the amount of off-balance sheet items in comparison to the capital of the banks, large loan exposures to capital, etc. are considered to calculate capital adequacy rating.
HHI (Herfindahl-Hirschman Index) has been incorporated in the updated CAMELS rating guideline to analyze loan concentration, as a complement to percentages of classified loans and provisioning in the evaluation of asset quality. The amount of loan disbursed to different risk associated sectors has been included as well. SME and Agriculture financing performance rating, Green banking and CSR performance rating, Spread rating are also considered in ‘Management’ part of CAMELS rating. Under this rating system, banking companies are assigned two sets of ratings- (i) performance ratings, based on six individual ratings that address six components of CAMELS (Capital Adequacy, Asset Quality, Management, Earnings, Liquidity and Sensitivity to Market Risk) and (ii) an overall composite rating based on a comprehensive assessment of the overall condition of the banking company. Both ratings are expressed by using a numerical scale of “1” to “5” in ascending order of supervisory concern, “1” representing the best rating, while “5” indicating the worst. Any bank rated 4 or 5, i.e., ‘Marginal’ or ‘Unsatisfactory’ under the composite CAMELS rating is generally identified as a problem bank, and the activities of these banks are closely monitored by BB.
At present, there are two problem banks, which are under intensive monitoring of BB. According to December 2018 based CAMELS Rating, no bank was rated ‘1’ or ‘Strong’; the rating of 39 banks was ‘2’ or Satisfactory’; rating of 10 banks was ‘3’ or ‘Fair’; 7 banks were rated ‘4’ or ‘Marginal’ and 1 bank received the rating of ‘5’ or ‘Unsatisfactory’.
BB had introduced Early Warning System (EWS) of supervision in March 2005 to address difficulties faced by the banks in any of the areas of CAMELS. Any bank found to have faced difficulty in any area operation, is brought under early warning category and monitored very closely to help improve its performance. Presently, there is no bank under EWS.