Chapter-5

Banking Sector Performance, Regulation and Bank Supervision

5.1 Industry statistics of the banking sector and the performance trends have been discussed in this chapter. The banking sector in Bangladesh comprises of four categories of scheduled banks. These are, nationalized commercial banks (NCBs), government owned development finance institutions (DFIs), private commercial banks (PCBs) and foreign commercial banks (FCBs). As of December 2004, total number of banks operating in Bangladesh remained unchanged at 49. These banks have a total number of 6,303 branches including 10 overseas branches. Structure of the banking sector with breakdown by type of banks is shown in Table 5.1. 5.2 In 2004, the nationalized commercial banks (NCBs) held 39.6 percent of the total industry assets against 41.7 percent in 2003. Evidently, NCBs' domination in this area is showing a declining trend, while PCBs share rose to 43.5 percent in 2004 against 40.8 percent in 2003. The foreign commercial banks held 7.2 percent of the industry assets in 2004, showing a little decrease by 0.1 percentage point over the previous year. There has been a decline in the operation of the DFIs with their shares of assets of only 9.7 percent in 2004, against 10.2 percent in 2003.
Table 5.1 Banking system structure
2003 Bank Number Number of types of banks branches NCBs DFIs PCBs FCBs Total 4 5 30 10 49 3,397 1,314 1,510 32 6,253 Total assets 631.6 154.5 617.8 110.1 1,514.0 % of industry assets 41.7 10.2 40.8 7.3 100.0 deposits

5.3 Total deposits of the banks in 2004 rose to Taka 1,326.1 billion from Taka 1,140.3 billion in 2003 showing an overall increase by 16.3 percent. The NCBs' (comprising of 4 largest banks) share in deposits decreased from 46.0 percent in 2003 to 42.8 percent in 2004. On the other hand, PCBs' deposits in 2004 amounted to Taka 588.0 billion or 44.3 percent of the total industry deposit against Taka 468.2 billion or 41.1 percent in 2003. FCBs' deposits in 2004 rose by Taka 11.00 billion or 13.0 percent over the previous year. The DFIs' deposits in 2004 were Taka 75.1 billion against Taka 62.6 billion in 2003 showing an increase of 20.0 percent over the year. Aggregated Balance Sheet 5.4 Assets: Aggregate industry assets in 2004 registered an overall increase by 14.0 percent over 2003. During this period, NCBs' assets increased by 8.2 percent and those of the PCBs rose by 21.2 percent. Loans and advances played a major role on the uses of fund. Loans and advances amounting to Taka 1,047.1 billion out of aggregate assets of Taka 1,725.5 billion

(billion Taka) 2004 % of Number Number of Total deposits of banks branches assets 46.0 5.5 41.1 7.4 100.0 4 5 30 10 49 3,388 1,328 1,550 37 6,303 683.7 167.9 749.3 124.6 1,725.5 % of deposits % of deposits industry assets 39.6 567.5 9.7 75.1 43.5 588.0 7.2 95.5 100.0 1,326.1 42.8 5.7 44.3 7.2 100.0

525.0 62.6 468.2 84.5 1,140.3

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Chapter-5

Banking Sector Performance, Regulation and Bank Supervision

Chart 5.1 Aggregate industry assets (Dec, 2003) (billion Taka)

Loans & advances, 918.3, 60%

Chart 5.2 Aggregate industry liabilities (Dec, 2003) (billion Taka)

Deposits, 1140.3, 75%

Govt. bills & bonds, 162.3, 11%

Deposit with BB, 84.1, 6%

Cash in tills, 13.4, 1%

other assets, 335.9, 22%

Capital & reserve, 76.8, 5%

Other liability, 296.9, 20%

Aggregate industry assets (Dec, 2004) (billion Taka)

Loans & advances, 1047.1, 61%

Aggregate industry liabilities (Dec, 2004) (billion Taka)

Deposits, 1326.1, 77%

Govt. bills & bonds, 190.9, 11%

Deposit Cash in tills, 15.5, 1% with BB, 86.3, 5%

other assets, 385.7, 22%

Capital & reserve, 92.7, 5%

Other liability, 306.7, 18%

constituted a significant portion (60.7 percent). Cash in tills were Taka 15.5 billion (below 1.0 percent), deposits with Bangladesh Bank were Taka 86.3 billion or 5.0 percent. Other Assets were Taka 385.7 billion or 22.4 percent and investment in government bills and bonds accounted for Taka 190.9 billion or 11.1 percent of the assets. 5.5 Liabilities: The aggregated liability portfolio of the banking industry in 2004 was Taka 1,725.5 billion of which deposits constituted Taka 1,326.1 billion or 76.9 percent and continued to be the main sources of fund of banking industry. Capital and reserves of the banks were Taka 92.7 billion or 5.4 percent of aggregate liabilities in 2004, against Taka 76.8 billion or 5.1 percent in 2003. Performance and Rating of Banks 5.6 Performance of the banking sector under CAMEL framework, which involves analysis,
30

and evaluation of the five crucial dimensions of banking operations, has been discussed in this chapter. The five indicators used in the rating system are (i) Capital adequacy (ii) Asset quality (iii) Management soundness (iv) Earnings and (v) Liquidity.

Capital Adequacy 5.7 Capital adequacy focuses on the total position of bank capital and protects the depositors from the potential shocks of losses that a bank might incur. It helps absorbing major financial risks (like credit risk, market risk, foreign exchange risk, interest rate risk and risk involved in off-balance sheet operations). Banks in Bangladesh have to maintain a minimum Capital Adequacy Ratio (CAR) of not less than 9.00 percent of their risk-weighted assets (with at least 4.50 percent in core capital) or Taka 1.00 billion whichever is higher.

Banking Sector Performance, Regulation and Bank Supervision

Chapter-5

Table 5.2 Capital to risk weighted assets ratio by type of banks

Bank type 1997 1998 1999 NCBs DFIs PCBs FCBs Total 2000 2001 2002 2003 4.3 7.7 10.5 22.9 8.4

Chart 5.3 Aggregate capital adequacy position

2004 4.1 9.1 10.3 24.2 8.7
1200 1000 Billion Taka 800 600 400 200 1997 1998 1999 2000 2001 2002 2003 2004 0 4 2 0 10 8 Percent 6

(Percent)

6.6 5.2 5.3 4.4 4.2 4.1 6.0 6.9 5.8 3.2 3.9 6.9 8.3 9.2 11.0 10.9 9.9 9.7 16.7 17.1 15.8 18.4 16.8 21.4 7.5 7.3 7.4 6.7 6.7 7.5

5.8 Table 5.2 shows that as on 31 December 2004 the DFIs, PCBs and FCBs maintained CAR of 9.1, 10.3 and 24.2 percent respectively. The 4 NCBs could not attain the required level. One of the DFIs and 5 PCBs failed to maintain required CAR. FCBs have the CAR much above the required standard at 24.2 percent but 2 of them maintained inadequate capital individually. Table 5.2 and Chart 5.3 reflect that the aggregate capital adequacy ratio of the banking sector showed a downward trend since 1997 and declined to 6.7 percent in 2000. However, in 2002, the ratio rose to 7.5 percent, i.e. to the 1997 level and in 2004 the ratio rose to 8.7 percent, the highest during the last 8 years. 5.9 The asset composition of all commercial banks shows the concentration of loans and advances (60.7 percent) in total assets. The high concentration of loans and advances indicates vulnerability of assets to credit risk, especially since the portion of non-performing assets is significant. A huge infected loan portfolio has been the major predicament of banks particularly of the state-owned banks. In the total assets, the share of loans and advances is followed by the investment in government securities and bills covering 11.1 percent. 5.10 The most important indicator intended to identify problems with asset quality in the loan portfolio is the percentage of gross and net non-performing loans (NPLs) to total assets and total advances. FCBs have the lowest and DFIs have the highest ratio of NPLs. NCBs have gross NPLs to total assets of 14.6 percent
31

Capital

RWA

Cap./ RWA

Table 5.3 Ratio of gross NPL* to total loans by type of banks

(Percent)

Bank type 1997 1998 1999 2000 2001 2002 2003 2004 NCBs DFIs PCBs FCBs Total 36.6 65.7 31.4 3.6 37.5 40.4 66.7 32.7 4.1 40.7 45.6 65.0 27.1 3.8 41.1 38.6 62.6 22.0 3.4 34.9 37.0 61.8 17.0 3.3 31.5 33.7 56.2 16.4 2.6 28.0 29.0 47.4 12.4 2.7 22.1 25.3 42.9 8.5 1.5 17.6

* Without adjustment for actual provision and interest suspense.

Chart 5.4 Aggregate position of NPLs to total loans

900 800 700 600 500 400 300 200 100 0 1997 1998 1999 2000 2001 2002 2003 2004 Total loans NPLs NPL ratio 50 40 Percent 30 20 10 0

whereas in case of PCBs, FCBs and DFIs, the ratios are 5.6 percent, 0.9 percent and 26.6 percent respectively. Similarly, NPLs net of provisions and interest suspense to the total assets is 9.1 percent, 2.1 percent and 10.5 percent for NCBs, PCBs and DFIs. FCBs are having excess provision for loan losses.

Billion Taka

Chapter-5

Banking Sector Performance, Regulation and Bank Supervision

5.11 The ratio of NPL to total loans of all the banks shows an encouraging trend since its decline from the peak (41.1 percent) in 1999, although the aggregate ratio is still as high as 17.6 percent in December 2004. The reason being very high NPL of the NCBs and the DFIs. 5.12 The NCBs and DFIs continue to have very high NPLs mainly due to substantial loans provided by them on considerations other than commercial and under directed credit programmes during the 70s and 80s. Poor appraisal and inadequate follow-up and supervision of the loans disbursed by the NCBs and DFIs in the past eventually resulted in massive booking of poor quality assets which still continue to remain significant in the portfolio of these banks. Furthermore, the banks were reluctant to write off the historically bad loans because of poor quality of underlying collaterals and to avoid any possible legal complication due to lacunas in the judicial framework. Recovery of NPLs however witnessed some signs of improvement; mainly because of the steps taken with regard to internal restructuring of these banks to strengthen their loan recovery mechanism and recovery drive and write off measures initiated in recent years. 5.13 It appears from the Table 5.3(a) and Chart 5.4 (a) that the net non performing loans to total loans after adjustment of actual provision and interest suspense stand at 17.6 percent (NCBs), 23.0 percent (DFIs), 3.4 percent (PCBs) and 9.8 percent (Banking Sector). NCBs' and DFIs' nonperforming portfolio is still high after adjustment of actual provision and interest suspense. 5.14 Chart 5.5 graphically displays the amounts in NPLs of the 4 types of banks since 1997 through 2003. Amount of NPLs of the NCBs increased from Taka 89.1 billion in 1997 to Taka 99.6 billion in 2004 although the ratio had declined. The PCBs also recorded a total increase of Taka 2.5 billion in their NPL accounts, which stood at Taka 41.9 billion in 2004 against Taka 39.4 billion in 1997. The amount of NPLs of the DFIs decreased to Taka 47.7 billion in 2004 from Taka 56.0 billion in 1997. The decline in NPL ratios in the recent
32

Table 5.3 (a) Ratio of net NPL to total loans by type of banks
(Percent)

Bank type 1997 1998 1999 2000 2001 2002 NCBs DFIs PCBs FCBs Total 31.4 56.9 25.1 -0.5 30.7 35.6 59.1 26.3 0.1 34.4 41.3 58.5 21.2 0.9 35.6 34.1 54.6 15.5 -0.1 28.8 32.8 54.5 10.5 -0.3 25.6 30.1 48.0 10.5 -0.4 22.6

2003 28.3 38.3 8.3 0.1 18.8

2004 17.6 23.0 3.4 -1.5 9.8

* Net of actual provision and interest suspense.

Chart 5.4 (a) Aggregate position of NNPL to total loans (net of provision)
900 800 700 600 500 400 300 200 100 0 1997 1998 1999 2000 2001 2002 2003 2004 Total loans (net of provision) Net NPLs NNPL ratio 40 35 30 25 20 15 10 5 0 Percent

years can be attributed partly to some progress in recovery of long outstanding loans and partly to write-offs of loans classified as 'bad' or 'loss' for over five years. Loan Loss Provisioning of the Banks 5.15 The Table 5.4 shows the aggregate amounts of NPLs of all banks, amounts of provision required to be maintained and the amounts actually provided by the banks from 1997 to 2004. 5.16 Table 5.4 and Chart 5.6 depict that in aggregate, the banks have been continuously failing to maintain the required level of provisions against their NPLs. During the years from 1997 through 2004, the banks could maintain 55.8 percent of the required provision in 2002; which declined thereafter to 40.9 percent in 2004. The

Billion Taka

Banking Sector Performance, Regulation and Bank Supervision

Chapter-5

Table 5.4 Required provision and provision maintained - all banks

All banks Amount of NPLs Required provision 1997 1998 1999 2000 2001 2002 2003

Table 5.5 Comparative position of provision adequacy

(billion Taka)

(billion Taka)

2004

Year 2003

Items Required provision Provision maintained Provision maintenance ratio

NCBs DFIs PCBs FCBs 53.3 3.5 14.7 14.6 23.1 17.5 1.4 1.7

173.3 214.3 238.8 228.5 236.0 238.6 203.2 187.3 79.1 93.5 100.2 50.1 51.5 98.4 101.6 106.8 58.1 61.4 59.6 92.5 37.3 55.2 87.8 35.9 51.9

Provision maintained 46.7

Excess(+)/shortfall(-) -32.4 -43.4 -48.7 -40.3 -40.2 -47.2

6.6% 99.2% 75.4% 125.2% 50.7 3.4 13.5 12.4 22.3 18.5 1.3 1.6

Provision maintenance ratio 59.1% 53.5% 51.4% 59.1% 60.5% 55.8% 40.3% 40.9% 2004 Required provision Provision maintained Provision maintenance ratio 6.7% 91.9% 83.0% 123.1%

main reason for the continuous shortfall in provision adequacy is the inability of the NCBs and some of the PCBs including those in problem bank category to make sufficient provisions due to inadequate profits and also transferred provision for write-off. Notably the FCBs are much better in that they have been able to make adequate provisions in the recent years. A comparative position as of end 2003 and 2004 is shown in Table 5.5. 5.17 Although some individual PCBs could make adequate provisions, the aggregate position did not improve mainly because of the huge provision shortfall of the banks in "Problem Bank" and "EWS" categories. Management Soundness 5.18 Sound management is the most important pre-requisite for the strength and growth of any financial institution. Since indicators of management quality are primarily specific to individual institution, these cannot be easily aggregated across the sector. In addition, it is difficult to draw any conclusion regarding management soundness on the basis of monetary indicators, as characteristics of a good management are rather qualitative in nature. Nevertheless, 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 gauge management soundness. In particular, a high and increasing expenditure to income ratio indicates the operating inefficiency that could be due to flaws in management.
33

Chart 5.5 Comparative position of NPLs by type of banks

140 120 100 Billion Taka 80 59.1 60 56.0 40 20 0 0.9 39.5 46.4 1.3 1998 89.1 63.7 66.7 107.6 128.9 117.3 122.3 121.8 105.7 99.6

63.3

61.6 47.3 47.7 41.9 1.1 2004 54.8

45.3 1.3 1999

46.2 1.3 2000

45.7 1.4 2001

48.5 1.7 2003

1.4 2002 DFIs

1997

NCBs

PCBs

FCBs

Chart 5.6 Provision adequacy position of all banks

300 250 Billion Taka 200 150 100 50 0 1997 1998 1999 2000 2001 2002 2003 2004 Amount of NPLs Provision maintenance ratio 70 60 50 40 30 20 10 0 Percent

Provision maintained

Chapter-5

Banking Sector Performance, Regulation and Bank Supervision

5.19 It transpires from Table 5.6 and Chart 5.7 that expenditure-income (EI) ratio of the DFIs was very high with 180.4 percent in 1998 and 175.3 percent in the year 2000. This was mainly because the DFIs made loan loss provisions by debiting 'loss' in their books. The position however improved after 2000 and the ratio came down to 89.1 percent and 95.9 percent in 2001 and 2002 respectively but again rose to 101.1 percent in 2003 and 104.0 in 2004 due to huge loss incurred by BKB (Bangladesh Krishi Bank). The EI ratio of the NCBs exceeded 100 percent in 1999 before falling to below 99 percent by end 2003 but again rose to 102.3 percent in 2004 due to loss incurred by Agrani Bank. Very high EI ratio of NCBs was mainly attributable to high administrative and overhead expenses, suspension of income against NPLs and making provision out of the profits made.

Table 5.6 Expenditure-income ratio by type of banks

Bank type 1997 1998 1999 2000 2001 2002 NCBs DFIs PCBs FCBs Total 99.4 99.8 100.5 99.4 99.0 142.3 180.4 145.2 175.3 89.1 85.9 85.3 90.4 90.8 88.1 59.7 60.1 67.4 77.7 75.7 95.3 95.4 96.6 99.9 91.2

(Percent)

2003

2004*

98.5 98.8 102.3 95.9 101.1 104.0 91.9 93.1 87.1 78.3 80.3 76.3 93.3 93.9 90.9

* Provisional.

Chart 5.7 Aggregate position of income and expenditure - all banks

150 Billion Taka 120 90 60 30 0 1997 1998 1999 2000 2001 2002 2003 2004 Total expenses Total income 95 90 85 EI ratio 105 100 Percent

Earnings and profitability 5.20 Strong earnings and profitability profile of a bank reflect its ability to support present and future operations. More specifically, this determines the capacity to absorb losses by building an adequate capital base, finance its expansion and pay adequate dividends to its shareholders. Although there are various measures of earning and profitability, the best and widely used indicator is returns on assets (ROA), which is supplemented by return on equity (ROE) and net interest margin (NIM).

5.21 Earnings as measured by return on assets (ROA) and return on equity (ROE) vary largely within the industry. Table 5.7 shows ROA and ROE by types of banks and Chart 5.8 shows the aggregate position of these two indicators for all banks. Analysis of these indicators reveals that the ROA of the NCBs has been very low and turned to negative in 2004, and that of the DFIs even worse. PCBs had an inconsistent trend and FCBs' return on assets ratio consistently declined from 4.8 percent in 1997 to 3.2 percent in 2004.

Table 5.7 Profitability ratios by type of banks

Bank types NCBs DFIs PCBs FCBs Total * Provisional. 1997 1998 0.0 0.0 -2.1 -2.8 1.1 1.2 4.8 4.7 0.3 0.3 Return on assets (ROA) 1999 2000 2001 2002 0.0 0.1 0.1 0.1 -1.6 -3.7 0.7 0.3 0.8 0.8 1.1 0.8 3.5 2.7 2.8 2.4 0.2 0.0 0.7 0.5 2003 0.1 0.0 0.7 2.6 0.5 2004* -0.1 -0.2 1.2 3.2 0.7 1997 1998 1.3 0.3 -29.1 -36.3 24.4 26.8 38.2 40.7 7.0 6.6 Return on equity ( ROE) 1999 2000 2001 2002 -1.1 1.7 2.4 4.2 -29.4 -68.0 12.3 5.8 15.3 17.0 20.9 13.6 41.8 27.3 32.4 21.5 5.2 0.3 15.9 11.6

(Percent) 2003 3.0 -0.6 11.4 20.4 9.8 2004* -5.3 -2.1 19.5 22.5 13.0

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Banking Sector Performance, Regulation and Bank Supervision

Chapter-5

Chart 5.8 Aggregate profitability-all banks

18 16 14 12 10 8 6 4 2 0 1997 Percent

Table 5.8 Net interest income by type of banks

Bank type 1997 1998 1999 2000 2001 2002 NCBs DFIs PCBs FCBs Total 2.7 -0.1 1.7 2.0 6.3 2.2 0.5 2.3 2.2 7.1 3.1 -0.1 3.0 1.8 7.8 -1.2 1.0 6.1 2.5 8.4 -1.8 2.7 9.2 3.3 13.4 -1.5 1.4 10.2 3.4 13.5

(billion Taka)

2003 -0.3 1.3 12.0 3.6 16.6

2004 -1.1 1.8 13.7 4.2 18.3

1998

1999 ROA

2000

2001

2002 ROE

2003

2004

Chart 5.9 5.22 NCBs return on equity ratio rose from -1.1 percent in 1999 to 3.0 percent in 2003 but again declined to -5.3 percent in 2004. In case of DFIs, the ROE sharply rose from -68.01 percent in 2000 to 12.3 percent in 2001 and again declined to -0.6 percent in 2003 and -2.1 percent in 2004. The sharp rise in 2001 was due to booking of net profit amounting to Taka 1.0 billion in 2001 against net loss of Taka 5.16 billion in 2000 by the DFIs. The huge loss of the DFIs in 2000 was mainly due to making of provisions by debiting 'loss' in their books of accounts. Aggregate NII of the industry (billion Taka)
90 80 Interest income & expense 70 60 50 40 30 20 10 0 1997 1998 1999 2000 2001 2002 2003 2004 Interest income Net interest income Interest expense 40 35 Net interest income 30 25 20 15 10 5 0

Net Interest Income 5.23 Aggregate net interest income (NII) of the industry has been positive and consistently increased from Taka 6.3 billion in 1997 to Taka 18.3 billion in 2004. However, the NII of the NCBs sharply declined from Taka 3.1 billion in 1999 to a negative amount of Taka 1.2 billion in 2000. The trend continued and the NCBs' interest income in 2001 was less by Taka 1.8 billion than interest expenses, and in 2002 by Taka 1.5 billion, in 2003 by Taka 0.3 billion and in 2004 by Taka 1.1 billion. The DFIs had a negative NII in 1997 and 1999, which was reversed in 2000 to Taka 1.0 billion and thereafter was positive in 2001 (Taka 2.7 billion), 2002 (Taka 1.4 billion), 2003 (Taka 1.3 billion) and 2004 (Taka 1.8 billion).
35

5.24 Although the net interest income of the NCBs has been negative during the last five years, the overall industry NII shows a consistently upward trend. This is because the rate of increase in NII of the PCBs and FCBs has been very high over the period from 1997 through 2004. This trend indicates that the PCBs and the FCBs are charging interests at very high rates on their lending as compared to the interest they are paying to the depositors.

Infrastructure and Operating Results 5.25 A comparative analysis of branches network, population and operating results by

Chapter-5

Banking Sector Performance, Regulation and Bank Supervision

Table 5.9 Banking infrastructure and operating expenses

Bank types NCBs DFIs PCBs FCBs Total Number of branches 2003 3,397 1,314 1,510 32 6,253 2004 3,388 1,328 1,550 37 6,303 Number of employees 2003 58,630 16,420 31,905 1,502 108,457 2004* 57,588 15,877 34,343 1,582 109,390 Number of Expenses Profit per Operating expenses Net profit (billion Taka) employees per employee employee (billion Taka) per branch (Taka) (Taka) 2003 2004 2003 2004* 2004 2004 2004 10.0 2.9 13.2 3.0 29.1 10.5 3.2 15.4 3.1 32.2 0.5 -0.1 4.3 2.8 7.5 -0.9 -0.2 9.3 3.9 12.1 17 12 22 43 18 182,300 201,600 448,400 1,959,500 294,400 -15,600 -12,600 270,800 2,465,200 110,600

* Provisional.

various types of banks during the last two years (2003 and 2004) has been conducted to indicate the recent industry trends in these areas. 5.26 Operating expenses of NCBs in 2004 increased by Taka 0.5 billion from the previous year. In case of PCBs, the operating expenses increased by Taka 2.2 billion during the same period with the increase in number of branches by 40. Expenses of the DFIs also increased from Taka 2.9 billion in 2003 to 3.2 billion in 2004. Expenses of FCBs were increased in 2004 by 0.1 billion than 2003. 5.27 Table 5.9 further shows that number of employees per branch was the highest (43) in the FCBs followed by the PCBs (22). Number of employees per branch of NCBs was 17 and DFIs 12 in 2004. Expenses per employee of the NCBs were Taka 182,300 and the DFIs Taka 201,600 in 2004. The NCBs and DFIs incurred loss in 2004. Their losses per employee were Taka 15,600 and Taka 12,600 respectively. The PCBs' profit per employee was Taka 270,800 against expenses

of Taka 4,48,400 per employee. FCBs' expenses per employee were as high as Taka 2.0 million against per employee profit of Taka 2.5 million in the year 2004. Evidently, there exists a positive correlation between the compensation and the employee output in general. Liquidity 5.28 Commercial banks deposits are at present subject to a statutory liquidity requirement (SLR) of 16 percent inclusive of average 4 percent (at least 3 percent) cash reserve requirement (CRR) on bi-weekly basis. The CRR is to be kept with the Bangladesh Bank and the remainder as qualifying secure assets under the SLR, either in cash or in government securities. SLR for the banks operating under the Islamic Shariah is 10 percent and the specialized banks are exempt from maintaining the SLR. Liquidity indicators measured as percentage of demand and time liabilities (excluding inter-bank items) of the banks indicate that all the banks had excess liquidity.

Table 5.10 Liquidity ratio by type of banks

Bank types NCBs DFIs PCBs FCBs Total 1997 22.7 16.9 24.2 31.2 23.3 1998 24.4 16.6 24.8 39.8 25.2 Liquid assets 1999 2000 25.2 26.5 15.7 16.2 25.9 24.8 51.3 34.7 27.0 26.1 2001 25.7 15.3 24.2 34.1 25.3 2002 27.3 13.7 26.3 41.6 27.2 2003 24.4 12.0 24.4 37.8 24.7 2004 22.8 11.2 23.1 37.8 23.4 1997 1998 2.7 4.4 9.7 9.2 6.0 6.7 11.2 19.9 4.5 6.4

(Percent) Excess liquidity 1999 2000 2001 2002 2003 2004 5.2 6.5 5.7 7.3 8.4 6.8 8.7 9.9 8.9 6.9 5.8 4.7 8.0 6.8 6.2 8.5 9.8 8.8 31.4 14.8 14.3 21.8 21.9 21.9 8.3 7.5 6.7 8.7 9.9 8.7

36

Banking Sector Performance, Regulation and Bank Supervision

Chapter-5

Chart 5.10 Aggregate position of excess liquidity

30 27 24 21 18 15 12 9 6 3 0

any of the areas of CAMEL. Any bank found to have faced difficulty in any areas of operation, is brought under Early Warning category and monitored very closely to help improve its performance. At present, 7 banks are in the EWS. 5.32 Bangladesh Bank is also monitoring the NCBs through its off-site supervision tools. Government of Bangladesh (GOB), the owner of those banks also adequately monitors them. At present, the NCBs are experiencing huge capital and provision shortfall, having large amount of classified loans, low earnings and ineffective management. Various restrictions have been imposed by the Bangladesh Bank on the activities of the NCBs to put them on right track of business operation and growth. All the 4 NCBs have been made to sign Memorandum of Understandings (MOUs) with the Bangladesh Bank to improve their performance. 5.33 As of end 2004, CAMEL rating of 12 banks was 1 or Strong; 15 banks were rated 2 or Satisfactory; rating of 10 banks was 3 or Fair; 8 were rated 4 or Marginal and 4 got 5 or Unsatisfactory rating. All the four NCBs had Marginal rating. Legal Reforms and Prudential Regulations Policy on Loan Classification and Provisioning 5.34 In order to strengthen credit discipline and bring classification gradually in line with the international standards, it has been decided that with effect from March 3, 2005: a continuous credit, demand loan or a term loan which will remain overdue for a period of 90 days or more, will be put into the " Special Mention Account" and interest accrued on such loan will be credited to Interest Suspense Account instead of crediting the same to Income Account. Loans in the ''Special Mention Account'' will not be treated as defaulted loan for the purpose of section 27ka ka (3) of the Banking Company Act, 1991 and the status of loan (Special Loan) need not to be reported to the Credit Information Bureau (CIB) of Bangladesh Bank. This will help the banks to look at accounts with potential problems in focused manner.
37

Percent

1997

1998

1999

2000

2001

2002

2003

2004

Liquidity maintained

Excess liquidity

5.29 Table 5.10 and Chart 5.10 show that the FCBs are having the highest liquidity ratios followed by the PCBs. This situation of constant surplus of liquidity warrants creation of effective demand for credit at lower costs. CAMEL Rating 5.30 Performance indicators of the banking industry depict a trend similar to that of the state-owned banks, which is understandable due to their predominant market share. Ratings done on the basis of the various indicators discussed hereinbefore indicate that financial performance of the PCBs and FCBs in general has been better than that of the industry average. However, 4 of the PCBs rated CAMEL 4 or 5 are still in the problem bank list out of 7 put in this category in the mid-nineties. Activities of the problem banks are closely monitored by the central bank with special guidance and care. One such bank was taken off the problem bank list in June 2003 and 2 others in 2000 and 2001 because of improved performance. Newly 2 banks are included in the problem bank list for their distressed financial position. At present 6 banks are in the problem bank list. 5.31 Presently Bangladesh Bank is employing Early Warning System (EWS) of supervision to address the difficulties faced by the banks in

Chapter-5

Banking Sector Performance, Regulation and Bank Supervision

Prudential Guidelines for Consumer Financing and Small Enterprise Financing 5.35 Since credit disbursement in the Consumer Financing sector has been significantly increased and credit flow in the Small Enterprise Financing sector has also been encouraged in the recent time, two separate guidelines have been issued to the banks for their better management of credit disbursed in those two sectors. However, implementation of these guidelines will be observed by Bangladesh Bank's inspection team while conducting their regular inspection in the scheduled banks. Single Borrower Exposure Limit 5.36 In order to enable the banks to improve their credit risk management through restriction on credit concentration BB has decided to reduce the single borrower exposure limit from 50% to 35%. The total outstanding financing facilities by a bank to any single person or enterprise shall not at any point of time exceed 35% of a bank's total capital subject to the condition that the maximum fund based credit facilities do not exceed 15% of its total capital. In case of export sector, single borrower exposure limit remains unchanged at 50% of a bank's total capital but funded facilities has been fixed at 15% of its total capital. Customer Complaint Cell 5.37 Banks have been advised to set up "Complaint Cell" to deal with all sort of complaints, either received directly by them or referred through different agencies/institutions, including BB. BB has also set up a "Complaint Cell" headed by a Deputy General Manager (DGM) in its Department of Banking Inspection (DBI). This Cell will check the performance, effectiveness and functioning of the Complaint Cells of the Banks, and monitor the status of customer complaints. Besides, a new page regarding complains has been opened in Website of Bangladesh Bank.

Cash Reserve Requirement (CRR) 5.38 The Cash Reserve Requirement (CRR) of the scheduled banks with the Bangladesh Bank which was fixed on 21 July, 2004 at 4.0 percent of their total demand and time liabilities (excluding inter-bank items). It was also mentioned in the circular that this amount of reserve must not be less than 3% in any single day. In pursuance of the objectives of monetary policy, CRR has been increased to 4.5% from 4% of their total demand and time liabilities effective from March 1, 2005. However, banks are allowed to maintain CRR @ 4.5% daily on bi-weekly average basis subject to the condition that CRR so maintained should not be less than 3.5% in any day.

Statutory Liquidity Requirement (SLR) 5.39 The Statutory Liquidity Requirement (SLR) for the scheduled banks, excepting banks operating under the Islamic shariah and the specialized banks, has been re-fixed at 16% from 20% on November 08, 2003 and remained unchanged thereafter. The SLR for the Islamic banks remained unchanged at 10.0 percent. The specialized banks continued to remain exempt from the SLR.

Interest Rate Policy 5.40 Since 25 April 1994, interest rate band for export credit had been fixed between 8.0 and 10.0 percent. From November 10, 2001, interest rate had been fixed at 7% for export credit of readymade garments, frozen foods and agro-based industrial products. However, from 23 February 2003, the same rate had been applied for export credit of leather made goods and shoes. From 02 November 2003, the lending rate for export financing of potato had been fixed at 8%. Thereafter, interest rate for all sorts of export credit has been fixed at 7% since January 10, 2004.

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With progressive deregulation of interest rates, banks have been advised to announce the midrate of the limit (if any) for different sectors and the banks may charge interest 1.5% more or less than the announced mid-rate on the basis of the comparative credit risk. Bangladesh Bank is keenly monitoring the movements of interest rates. Bank Rate 5.41 The bank rate has been revised downward from 6 percent to 5 percent on 06 November 2003 and remained unchanged as on date. Activities of Credit Information Bureau (CIB) 5.42 In the backdrop of huge non-performing loan of the banking sector of the country during the decade of the 1980s, a full-fledged Credit Information Bureau (CIB) was set up in August 18, 1992 in Bangladesh Bank under FSRP of the World Bank. The main objective behind setting up of the Bureau was to minimize the extent of default loan by facilitating the banks and financial institutions with credit reports of the loan applicants so that the lending institutions do not encounter any credit risk while extending any lending or rescheduling facility. 5.43 The workload of the Bureau kept on increasing in terms of number of requests, number of borrowers and owners, number of reporting banks/financial institutions as well as number of branches. CIB database consists of detailed information in respect of borrowers, owners and guarantors; the total number of which was 806,165 (end June, 2005) recording an increase of 19.97 percent over the previous period (672,000 as on end June, 2004). The number of CIB reports supplied during FY05 stood at 377,350 compared to 338,741 in the FY04 showing an annual increase by 11.4 percent. As per existing service standard, the credit reports are supplied within 5 working days of receiving the request the volume of which was around 1300 per day during FY05.
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5.4 The achievement of Credit Information Bureau in fulfilling its objectives of bringing down the extent of default loan has been found quite remarkable. As per reporting of scheduled banks, the classified loan continued to decline during the FY05. The classified loan decreased to 14.71 percent in June 2005 compared to 23.06 percent in the preceding year (end June 2004). A few years back, the percentage of such classified loan was 34.9 percent (in December 2000). It may be mentioned that with effect from June 2004 quarter the amount of 'Write-off' was excluded from both classified and outstanding loans while evaluating the percentage of classified loans. 5.45 In order to ensure prompt collection of credit data from the sources as well as instantaneous delivery of credit report to the users by applying latest computer technology, the CIB would soon undertake a project aimed at implementing on-line services between the Bureau and the lending institutions by using internet. The project of implementing on-line connectivity between CIB and the head offices of the banks and financial institutions is expected to complete by the year 2006. Inspection of Banks 5.46 Bangladesh Bank, being the Central Bank of the country, is entrusted with the responsibility to regulate and supervise the banks and financial institutions of the country. Inspection of banking companies is assigned to Bangladesh Bank under section 44 of Bank Company Act 1991. Two departments of the Bank namely Department of Banking Inspection-1 and Department of Banking Inspection-2 are conducting the inspection activities. These two departments conduct on-site inspection on Nationalized Commercial Banks (NCBs), Specialized Banks, Private Commercial Banks (including Foreign Banks) and other institutions including Investment Corporation of Bangladesh (ICB) and Money Changers. Basically, two types of inspections are conducted namely (i) comprehensive inspection and (ii) special inspection. In

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comprehensive inspection, overall performance/ conditions of the banks such as capital adequacy, asset quality, liquidity, earnings, management competence etc. are evaluated. Based on their performance banks are rated between 1-5 grades in ascending order. Inspection is done according to the Annual Inspection Programme (AIP) chalked out by the departments well ahead of the beginning of each calendar year. These departments also monitor implementation of the suggestions/ recommendations made in the inspection reports. Special inspections are conducted on the banks on specific/particular issue(s) as well as to investigate complaints received from the depositors, general public or institutions. Moreover to oversee risk management practice of the banks/implementation of core risk management guidelines by the banks, systems inspection has been introduced from October 2004. 5.47 Commercial banks having CAMEL rating between 3-5 are inspected every year. Banks rated 1 or 2 are inspected once in two years. Branches of scheduled banks covering around 50 percent of total loans and advances are normally brought under the comprehensive inspection programme every year. Commencing from 2004, inspections of the banks are conducted based on four reference dates : 31 December, 31 March, 30 June and 30 September instead of only one reference date i.e. 31 December of the previous year. This system has been adopted to enhance the effectiveness of on-site inspection and to reduce the time-gap between on-site and off-site supervision. 5.48 These departments inspected a total number of 2,131 branches of bank companies under comprehensive inspection programme during FY05 including 51 head offices, 629 big branches and 1,451 small branches. Under the special inspection programme, a total number of 1,476 inspections were carried out during FY05 including 334 inspections on Money Changers.
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Non-Bank Financial Institutions (NBFIs) 5.49 NBFIs represent one of the most important segments of a financial system and play very important role in mobilizing and channeling resources. In Bangladesh, the non-bank financial sector comprises investment and finance companies, leasing companies etc. The NonBank Financial Institutions (NBFIs) numbering 28 as of June 2005 (starting from the IPDC in 1981) are regulated by the Financial Institutions Act, 1993 and the regulations made thereunder. In view of their increased role in financing industry, trade and commerce, and housing the minimum capital requirement of the NBFIs was raised to Taka 0.25 billion as per FID Circular 2, dated 29th June 2003. NBFIs were directed to meet up the minimum 50 percent of the deficit in capital within 30 June 2004 and the rest 50 percent of the deficit within June 2005. Most of the NBFIs have raised their required capital by June 2004. All FIs have been asked to raise their required capital through IPO (Initial Public Offering) within December 2005. The amount of total paid up capital and reserve of NBFIs thus increased to Taka 12.46 billion as of June 2005. NBFIs are allowed to collect fund from the call market up to 15 percent of their total assets for their investment purpose. The financing modes of NBIs are long term in nature. Total investment by the NBFIs up to June 2005 was Taka 60.91 billion, which is 51.33 percent higher than that of the previous year (Taka 40.25 billion as of June 2004). The rate of default in the non-bank financial sector is quite low. As of June 2005, classified loans and leases of the NBFIs in aggregate were 6.81 percent (1.42% after deduction of provision and interest suspense).

Financial Institutions Development Project 5.50 The Financial Institutions Development Project (FIDP), administered by the Bangladesh Bank, was formally launched in February 2000 as per the Development Credit Agreement (DCA) signed between the Government of the

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People's Republic of Bangladesh and the International Development Association (IDA). The duration of the project was five years. However, the project period has been extended up to February 2006. The total project cost is USD 57.69 million (IDA - USD 46.90 million, GOB - USD 5.41 million and others - USD 5.38 million). The major objective of the FIDP is to promote the development of Financial Institutions (FIs) and improvements in investment financing on a sustainable basis through strengthening the quality of intermediation with a view to accelerating industrial growth in Bangladesh. The project consists of two Components : (a) resource mobilization for FIs and (b) strengthening of FIs through developing and managing a credit bridge and standby facility. Besides, establishing a strong capital market, the FIDP aims to reform the National Savings Schemes (NSS), activate a secondary market for treasury securities and devise procedures for the issuance and marketing of debt instruments. Credit Bridge and Standby Facility (CBSF) has already been established. Up to June 30, 2005 a total of Taka 2.4 billion (USD 42.31 million)

has been disbursed to the five Participating Financial Institutions (PFIs) against 136 subprojects. The PFIs in turn have made a repayment of Taka 1.62 billion. Financial and technical assistance is being provided to those PFIs who want to mobilize mid term and long term resources through issuing bonds and debentures. The PFIs have mobilized resources through issuing debentures/bonds to the tune of Taka 1328.33 million (IDLC-Taka 343.33 million, ULC Taka 415.00 million, GSP - Taka 80.00 million and IPDC - Taka 280.00 million, PFIL-210.00 million). All the debentures/bonds under the FIDP had to be issued under private placement due to regulatory and other impediments. Besides, steps were taken to create an enabling environment for the issuance of the securitized debt instruments. So far three PFIs have been given NOC to form SPV for the purpose of issuing Zero-coupon Bonds with a total face value of Taka 948.58 million (IPDC - Taka 358.58 million, IDLC - Taka 190.00 million, ULC - Taka 400 million). The prospect of securitizing the receivables of Jamuna Multipurpose Bridge with the technical support of FIDP is currently under consideration.

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