Analysis: Problem banks and governance in the banking system


This is part of a special series that offers a retrospective look at Bangladesh’s financial sector

This article continues on the issue of governance of the banking system.

The first article described how the banking system operates under the guidance and regulation of the Bangladesh Bank in the management of non-performing loans.

The second article dealt with the role of the board of directors of the commercial bank in governance.

This article discusses the issue of troubled banks and how the central bank can tackle these banks.

The management by the Bangladesh Bank of the private banking sector over the next two years is a matter of great importance for the functioning of the economy and the maintenance of rapid economic growth.

The essence of economic growth is to direct savings towards the most profitable investment projects.

The banking system is the key organization in which such decisions and connections are made.

In recent years, the efficiency of the private banking system has declined, in part due to excessive tolerance.

Distressed banks have one or more of the following conditions:

· Depositors have difficulty withdrawing their funds on demand.

· The bank has an increasing level of nonperforming loans.

· The bank is unable to maintain the required capital and is not making any progress in correcting this condition.

· There is a slow decline in the level of deposits.

· The bank is having difficulty borrowing in the day-to-day interbank market.

Problem banks emerge from making poor quality loans or breaking the rules:

Loans are made to people of bad character, usually partners of an administrator

Loans granted to relatives of an administrator

Scams where loans are given to non-existent businesses

Inadequate collateral due to loan officer laziness or willful deception

Weak loan recovery procedures

· Failure of loan officers to maintain regular contact with borrowers; or the lack of collection of appropriate information on the financial situation of the borrower.

Competent staff following appropriate procedures will report problem loans allowing the bank to take corrective action.

Poor loan portfolios can only come from the weakness of senior management or administrators who have an interest in a loan defaulting.


Also Read – A Retrospective Look at Bangladesh’s Financial Sector

Also Read – A Retrospective Look at Bangladesh’s Financial Sector: Part 2

Also Read – A Retrospective Look at Bangladesh’s Financial Sector: Part 3

Read also – Analysis: Interest rates and deposits

Read also – The state of lending rates – Part 1

Read also – Analysis: The state of lending rates – Part 2

Read also – Ever higher NPLs and bankers’ dilemma

Read also – The dilemma of NPL management

Also Read – A Retrospective Look at Exchange Rate Management in Bangladesh

Also Read – Summarizing Four Relevant Problems

Read also – Governance in the banking system

Read also – Analysis: The board of directors of the bank – governance of the banking sector


When a bank begins to show signs of a poor portfolio, the central bank should take immediate action to demand improvements and carefully monitor the actual capital position of the bank.

It is not the job of the Bangladesh Bank to help a commercial bank use cover-ups and forbearance to cover up the problem.

Rather, it is the task of the Bangladesh Bank to demand and insist on corrective measures.

Falling capital is one of the most immediate signals for a bank in trouble.

Such a condition forces the directors of the troubled bank to take aggressive action to raise the necessary capital.

It is quite a difficult problem.

There are three sources of additional capital: Existing shareholders; the issuance of new shares or bonds to nationals; or sell stocks or bonds to foreigners.

Directors are still reluctant to dilute their holdings [reducing their dividends]; bond issuance is still in its infancy and many questions remain unanswered.

The essence of bank capital is that when the bank loses money, the capital is reduced but the depositors’ money is protected.

The depositor only loses once the shareholders have lost all of their investment.

A perpetual bond that pays a fixed return regardless of the bank’s performance is not capital.

The owner of the bond can be protected against loss at the same level as the depositor.

Foreigners may very well be interested in acquiring a stake in a bank, but they will do so after due diligence involving the bank, its directors and senior management.

Most private banks will not present a convincing case.

Remedies

If the directors are unable to correct the lack of capital, more vigorous action is needed.

The Bangladesh Bank will require the troubled bank to merge with another bank and the combined balance sheets provide the required capital.

Of course, this means that many people will no longer be directors and the owners of the weak bank will find their stocks to be of little value.

The Bangladesh Bank was generally looking for a way to merge the problematic bank.

This can be managed under existing securities laws, although there may be litigation to prevent such a merger.

One obvious problem is the slowness with which courts can deal with litigation; the troubled bank cannot continue for years to wait for the courts to settle the dispute.

I doubt the slowness of the courts can be improved, so merging a weak bank with a stronger bank is an unlikely fix to the problem.

The only other way is for Bangladesh Bank to take over the problem bank and find a way for its future.

If a bank reaches this point, depositors try to withdraw their funds and borrowers avoid repaying, so the condition of the bank deteriorates rapidly.

The main effort should focus on loan recovery. There are many things that can be done: All loans classified as impaired or uncollectible must be collected in court.

The CIB must confirm that all these borrowers are listed and BB must inform all banks that no credit can be given to defaults.

Problem bank records should be reviewed to determine if there is inappropriate pressure from directors or senior management to issue loans that have been assessed as poor quality.

Any such example should be the basis for legal action to recover funds from the director or manager concerned.

The Bangladesh Bank should do everything possible to collect the loans.

Depositors must be reimbursed if they wish to recover their deposits, but early withdrawal of term deposits can be avoided.

The Deposit Insurance Fund can be used to reimburse depositors within the permitted limits.

The Bangladesh Bank will need to lend money to the ailing bank, but a vigorous cost-cutting program is expected to be implemented.

Loans that appear to be collectable can be restructured and rescheduled.

Within a reasonably short period of time, not exceeding 18 months, the condition and potential of the problematic bank can be reviewed and a decision made: (1) Close the bank; pay depositors where possible; establish a special unit at the Bangladesh Bank which will take charge of unpaid loans and make an ongoing effort to collect what is owed. (2) Bid the bank under the conditions: the winning bid takes the bank in the state it is in when the auction is announced; buyers will bring the bank to capital adequacy; all staff are made redundant and paid by BB.

The new owner will hire his own staff.

All funds loaned to the bank by BB will be repaid over a long period at a very low interest rate.

These conditions are intended to be illustrative but it is a question of going in one of two directions: closing or auction.

If the bank is closed, if there is value left after all the contributions have been paid [including any use of the Deposit Insurance], with uncollected loans valued at zero, the owners of the bank will receive their share of the remaining capital.

If the bank is auctioned off, the original owners will not receive anything.

There are at least two private banks that should be bought out in this way and sold by auction or closure unless a merger can be completed.

One action that should be considered is to change the size of deposits covered by insurance. Maybe deposits up to Tk10 lakh could be covered.

This would ensure 98% of deposit accounts and 33% of the value of deposits for private banks.

Of course, the premium must also be increased.

This would protect most depositors, reduce the risk of bank runs and stabilize private banks.

Forrest Cookson is an economist who was the first chairman of AmCham and was a consultant for the Bangladesh Bureau of Statistics

About Ruben V. Albin

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