change in financial sector of bangladesh

7/28/2019 Change in Financial Sector of Bangladesh

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SAJID ZAMAN DU EMBA ( Banking & Insurance)

Change in Financial Sector of Bangladesh:

An Analysis

Abstract

The financial sector of Bangladesh is generally small and underdeveloped.

This sector consists of a banking segment and an emerging but still nascent

capital market segment. The banking segment in the country is relatively more

developed than the equity market segment, even though both are quite

underdeveloped in international comparison. The root causes of the

Bangladeshi financial sector problem are the lack of market discipline due to

lack of competition in the banking industry. Excessive government intervention

and political connections, economic and political corruptions, operational and

managerial inefficiency and ineffectiveness result in vicious circle that inhibits

economic development, industrialization, and social progresses in poor and

developing countries in general and in Bangladesh in particular. Better

financial services and diversified financial products would be the natural

consequence of competitive financial industry. The authors argue that a

strengthened regulatory environment and additional much needed financial

sector reforms, a better and more efficient financial sector may evolve over

time and serve better the development needs of the country.




1.0 Introduction

Since the independence of the country on December 16th, 1971 until December

1989, the Bangladeshi financial sector has been controlled under the strict

directives of government and Bangladesh Bank-the Central Bank of

Bangladesh. From 1974, the discount rate policy was often used to support

Bangladesh Bank‟s administered interest rate policy. In the early years of

Bangladesh, discount rate, reserve ratios and moral suasion (known as open

mouth operation) were important instruments to control money supply. With

the introduction of Financial Sector Reform Program in 1990, the Bangladesh

Bank almost closed both the refinance and rediscount windows with a view to

developing an inter-bank market. Nevertheless the central bank kept the

discount rate between 5-8 percent. Any bank that needed finance startedapproaching the inter- bank market instead of Bangladesh Bank‟s windows;

thereby, discount rate policy, though intentionally, lost its credibility.

The banking system at independence consisted of two branch offices of the

former State Bank of Pakistan and seventeen large commercial banks, two of

which were controlled by Bangladeshi interests and three by foreigners other

than West Pakistanis. There were fourteen smaller commercial banks. Virtually

all banking services were concentrated in urban areas. The newly independent

government immediately designated the Dhaka branch of the State Bank of

Pakistan as the central bank and renamed it the Bangladesh Bank. The bank

was responsible for regulating currency, controlling credit and monetary policy,

and administering exchange control and the official foreign exchange reserves.

The Bangladesh government initially nationalized the entire domestic banking

system and proceeded to reorganize and rename the various banks. Foreign-

owned banks were permitted to continue doing business in Bangladesh. The

insurance business was also nationalized and became a source of potentialinvestment funds. Cooperative credit systems and postal savings offices

handled service to small individual and rural accounts. The new banking

system succeeded in establishing reasonably efficient procedures for managing

credit and foreign exchange. The primary function of the credit system

throughout the 1970s was to finance trade and the public sector, which together

absorbed 75 percent of total advances.




The government's encouragement during the late 1970s and early 1980s of

agricultural development and private industry brought changes in lending

strategies. Managed by the Bangladesh Krishi Bank, a specialized agricultural

banking institution, lending to farmers and fishermen dramatically expanded.

The number of rural bank branches doubled between 1977 and 1985, to morethan 3,330. Denationalization and private industrial growth led the Bangladesh

Bank and the World Bank to focus their lending on the emerging private

manufacturing sector. Scheduled bank advances to private agriculture, as a

percentage of sectoral GDP, rose from 2 percent in FY 1979 to 11 percent in

FY 1987, while advances to private manufacturing rose from 13 percent to 53

percent.

The transformation of finance priorities has brought with it problems in

administration. No sound project-appraisal system was in place to identifyviable borrowers and projects. Lending institutions did not have adequate

autonomy to choose borrowers and projects and were often instructed by the

political authorities. In addition, the incentive system for the banks stressed

disbursements rather than recoveries, and the accounting and debt collection

systems were inadequate to deal with the problems of loan recovery. It became

more common for borrowers to default on loans than to repay them; the lending

system was simply disbursing grant assistance to private individuals who

qualified for loans more for political than for economic reasons. The rate of

recovery on agricultural loans was only 27 percent in FY 1986, and the rate on

industrial loans was even worse. As a result of this poor showing, major donors

applied pressure to induce the government and banks to take firmer action to

strengthen internal bank management and credit discipline. As a consequence,

recovery rates began to improve in 1987. The National Commission on Money,

Credit, and Banking recommended broad structural changes in Bangladesh's

system of financial intermediation early in 1987, many of which were built into

a three-year compensatory financing facility signed by Bangladesh with the

IMF in February 1987.

One major exception to the management problems of Bangladeshi banks was

the Grameen Bank, begun as a government project in 1976 and established in

1983 as an independent bank. In the late 1980s, the bank continued to provide

financial resources to the poor on reasonable terms and to generate productive

self-employment without external assistance. Its customers were landless

persons who took small loans for all types of economic activities, including

housing. About 70 percent of the borrowers were women, who were otherwisenot much represented in institutional finance. Collective rural enterprises also




average loan by the Grameen Bank in the mid-1980s was around Tk2,000

(US$65), and the maximum was just Tk18,000 (for construction of a tin-roof

house). Repayment terms were 4 percent for rural housing and 8.5 percent for

normal lending operations.

The Grameen Bank extended collateral-free loans to 200,000 landless people in

its first 10 years. Most of its customers had never dealt with formal lending

institutions before. The most remarkable accomplishment was the phenomenal

recovery rate; amid the prevailing pattern of bad debts throughout the

Bangladeshi banking system, only 4 percent of Grameen Bank loans were

overdue. The bank had from the outset applied a specialized system of

intensive credit supervision that set it apart from others. Its success, though still

on a rather small scale, provided hope that it could continue to grow and that it

could be replicated or adapted to other development-related priorities. The

Grameen Bank was expanding rapidly, planning to have 500 branches

throughout the country by the late 1980s.

Beginning in late 1985, the government pursued a tight monetary policy aimed

at limiting the growth of domestic private credit and government borrowing

from the banking system. The policy was largely successful in reducing thegrowth of the money supply and total domestic credit. Net credit to the

government actually declined in FY 1986. The problem of credit recovery

remained a threat to monetary stability, responsible for serious resource

misallocation and harsh inequities. Although the government had begun

effective measures to improve financial discipline, the draconian contraction of

credit availability contained the risk of inadvertently discouraging new

economic activity.

Foreign exchange reserves at the end of FY 1986 were US$476 million,

equivalent to slightly more than 2 months worth of imports. This represented a

20-percent increase of reserves over the previous year, largely the result of

higher remittances by Bangladeshi workers abroad. The country also reduced

imports by about 10 percent to US$2.4 billion. Because of Bangladesh's status

as a least developed country receiving concessional loans, private creditors

accounted for only about 6 percent of outstanding public debt. The external

public debt was US$6.4 billion, and annual debt service payments wereUS$467 million at the end of FY 1986.




The financial sector of Bangladesh is generally small and underdeveloped. This

sector consists of a banking segment and an emerging but still nascent

capital/equity market segment. The banking segment in the country is relatively

more developed than the equity market segment, even though both are quite

underdeveloped in international comparison. The primary research question of the study is to examine the current state of the financial sector and whether it

can play an important and necessary role in resource mobilization and

economic development of the country. A brief analysis of the two major

segments of the country‟s financial system is given in the following two

sections, with the banking segment discussion first followed by a discussion of

the equity market segment. The next section discusses challenges; the final

section providing some concluding remarks.




2.0 Banking Industry

In the banking segment, immediately after the independence of the country in

1971, the then government nationalized the commercial banks (except a few

foreign banks) and organized them into six distinct banks by the BangladeshBank (the central Bank of the country) nationalization order 1972. As saving

and investment in the country is very low, in order to channel saving and

investment through the formal sector and to expand banking services in the

remote areas of the country, the nationalization of the banking sector was

considered as one of the major objectives at that time. The central bank, known

as the Bangladesh Bank (BB) is the central body to oversee the banking sector

of the country and at that time, the BB directly controlled the interest rates

(both lending and deposit rates) by fiat.

During this time, bank branches have expanded rapidly, particularly in the rural

areas. On the positive side, the expansion of bank branches reduces transaction

costs associated with the mobilization and transfer of funds and to thereby to

increase savings and investments, and deposit creation. But due to corruption,

mismanagement, and government interference, many branches of the

commercial banks cannot work properly and some branches incurred heavy

losses, and some of these branches were subsequently closed down. To

overcome these problems, financial sector reform program has started inearnest since 1990. These reforms include flexible interest rate, convertibility

of „taka‟, introduction of 91 days bill, recapitalization of banks, and new

procedures for loan classification system, introduction of REPO in the money

market, and strengthening of money and capital markets. Although before

1990, open market operations and bank rate policies were hardly used,

currently they are getting emphasis due to change in the post-reform policy

environment.




In the initial years after independence, six nationalized commercial banks

(NCB‟s) dominated the banking segment. In the post reform period, the

structure of the banking system has changed significantly. Total numbers of

scheduled banks are forty seven. As part of the reform program, some NCB‟s

were privatized, foreign ownership of banks has been opened up, and additionalnew commercial banks were allowed to start and operate. Consequently, the

banking system in the country consists of several NCB‟s along with a number

of home based privately owned commercial banks (PCB‟s), some foreign

owned commercial banks (FCB‟s), some privately owned Sharia compliant

Islamic banks (IB‟s) and some state owned specialized financial institutions

(SFI‟s) such as the Bangladesh Krishi (agricultural) Bank and Bangladesh

Development Bank ltd., all under the supervision of the central bank. Besides

that, the Investment Corporation Bank (ICB) also plays vital role as an

investment banking .Unfortunately for the last ten years, their services were not

active like previous time periods, though it has been divided into three wings

with the objective of improving its performance.

Table:-5.1:Total assets and deposits scenario by types of bank.

2010 (June) ( billion Taka)

Bank Number Number Total % of Deposits % of Depositstypes of Banks of Assets Industry

branches Assets

SCBs 4 3394 1272.64 28.85 952.72 28.62

DFIs 4 1366 291.37 6.60 177.90 5.34

PCBs 30 2427 2539.27 57.55 1967.78 59.11

FCBs 9 59 308.70 7.00 230.68 6.93

Total 47 7246 4411.98 100 3329.08 100

Source: Bangladesh Bank (2010).




In spite of many different kinds of banks operating side by side, and even

though the central bank no longer directly control the lending or deposit rates in

the post-1990‟s reform period; however, a strong competitive and efficient

banking system has not yet developed. The banking system is mired in

corruption, mismanagement, and direct interference from government in power.Further, the commercial banks still do not determine interest rate under

competitive environment. Rather they are determining interest rates (both

lending and deposit rates) within an oligopolistic framework, possibly

following some collusive or cartel type arrangements. This is perhaps true for

all types of banks, nationalized banks, domestic private banks and foreign

owned banks.

The last decade witnessed some major policy shift as the Bangladesh Bank

introduced repurchase agreement in July 2002 and Reverse Repo in April 2003

and reintroduced Bangladesh Bank Bill in 2006. These were introduced as

indirect monetary policy tools for day-to-day liquidity management in response

to temporary and unexpected disturbances in the supply of and demand for

money. The initiatives of the Central Bank to face the situation through reform

measures since 1990 no doubt have improved the capital adequacy,

governance, regulation and supervision, and the legal and payment systems in

the economy. Nowadays, the traditional banking business system of the country

through depositing and advancing of money has almost ended. Segmentation inthe banking system is required so that banks‟ can provide a broad range of

financial services. Through fund management, banks can earn profit.




The banking sector has evolved to become the dominant financial intermediary

in Bangladeshi financial system due to the underdeveloped money and capital

markets, limited availability of financial instruments, and lack of confidence in

the financial system as a whole. Bangladesh Bank still cannot determine

monetary policy independently. Government is still playing important role inthe financial sector as borrowers from the banking system. In Bangladesh, there

is very limited scope for individuals to invest in the capital markets and lack of

alternative opportunities for investment compelled them to invest mainly in

bank deposits, post office saving certificates and government bonds. Banks

operate with old and outdated banking procedures, lack of coordination

between proper manpower planning and bank schemes, lack of market research

for customer psychology analysis, scarcity of financial derivatives, inefficient

banking services, and lack of long term planning, to name a few, are creating

bottlenecks preventing local banks from attaining international standards.

Though reform measures in the financial sector were initiated in the nineties,

the overall stability and performance of the banking sector is still not

satisfactory.

Financial institution managers in general, and bank managers in particular, in

this country does not properly assess risks as well as the costs of various types

of bank sources of funds. While managing their financial assets, the financialinstitutions were not cautious about handling funds with the utmost care. Lack

of ethics in the banking sector is a part of a wider and long lasting socio-

economic and political problems in Bangladesh. Loopholes in the financial

sector are a part of the overall corruption that plagued almost all segments in

the country. Unhealthy competition among different banks display lack of

ethics in doing banking business. Variation of higher interest rate and profit

paid to the client sometimes involve bankers in immoral practices. In the name

of trade unionism, especially nationalized commercial banks, trade union

leaders create unethical work culture in Bangladesh. Pervasive corruption inBangladesh is a form of agency problem in which bank management tries to

maximize the amount of its personal gains (bribery) has been documented in

the literature.




ADB (2011) argued that the half-yearly monetary policy statement (MPS, July-

December 2011) aims to continue the central bank‟s tighter monetary policy

stance to rein in credit expansion to control inflation and preserve external

sector balance. Economic Trends (2011) indicated that the annual rate of

inflation increased to 9.43 percent at the end of August „11 from 7.87 per centat the end of august ‟10.

Bangladesh Bank (2011) described that in bolstering stability of the financial

sector include mandatory implementation of the BASEK – II capital regime

from 2010, with the attendant shoring up of risk management structures and

practices that this will entail. Mandatory periodical stress testing routines in

banking sector have also been introduced to bring out early warnings about

their vulnerabilities.

Bangladesh Bank cannot guide commercial banks as evidenced by the fact that

commercial banks are charging higher interest rates, even cross the limit of

margin requirements, taking high spread between buying and selling rate of

foreign exchange and devaluation of Bangladesh Taka against US Dollar has

been going on. As such inflation rate is rising and purchasing power of the

people has been declining Moreover, commercial banks are investing in the

share market to gain short term profit since 2005 making depositors deposit

risky as in Bangladesh if any bank fails then there is no reinsurance systemfrom which depositors get their amount. These problems cannot be corrected

without the infrastructure of the more modernized banking sector and proper

staffing in the top management level i.e. Deputy Governor posts where one

should be macroeconomic specialist and another one should have depth

knowledge in practical commercial banking and developing an effective and

efficient market economy. Moreover, government should take appropriate steps

to develop bond market so that it can contribute in the growth of Gross

domestic Product.

From the countercyclical monetary policy time lag perspective, empirical

research suggests that when formulating the current countercyclical monetary

policy, Bangladesh Bank is influenced by its actions taken in the last three

quarters and the change in the real GDP a year ago. The countercyclical

monetary policy actions and the change in the real GDP a year ago affect the

current change in the real GDP. Stated differently, it will take two quarters for

the implemented countercyclical policy to achieve it effectiveness fully

Customarily, the time period when the adverse economic condition occurs until




however long it take for the Bank of Bangladesh to recognize the

macroeconomic problem and to formulate and implement the corrective policy

actions, it will take two quarters for the implemented countercyclical monetary

policy to achieve its full effectiveness.

Figure-5.1: Percentage (%) of Industry Assets by Types of Banks.

% of Industry Assets

7.00% 28.85%

6.60% 57.55%

SCBs DFIs PCBs FCBs

Source: Bangladesh Bank (2010)

Figure-5.2: Percentage (%) of Industry Deposits by Types of Banks.

% of Industry Deposits

6.93% 28.62%

5.34%

59.11%

SCBs DFIs PCBs FCBs

Source: Bangladesh Bank (2010)




3.0 Equity Markets

As to the capital market segment, Bangladesh is still at a nascent stage of

capital market development. It is well documented in the literature that a well-

functioning capital market is of great significance for a developing country like

Bangladesh which is expected to help the country‟s development by channeling

domestic saving to productive investments, attracting foreign investors to the

market, and allocating the national savings most efficiently, among others.

However, as in many other developing country equity markets, the Bangladesh

equity market is relatively underdeveloped, it is small, the market is thin and

non-transparent, and it is quite inefficient.

Bangladesh has two major exchanges, the Dhaka Stock Exchange (DSE) andthe Chittagong Stock Exchange (CSE). The DSE is the larger of the two stock

exchanges in the country. Formal trading on the DSE began in 1956 two years

after the establishment of the East Pakistan Stock Exchange Ltd. on April 28,

1954. It was renamed as the East Pakistan Stock Exchange Limited on June 23,

1962, and finally came to be known by its present name of the Dhaka Stock

Exchange (DSE) Limited on May 14, 1964.

Prior to the independence of Bangladesh in 1971, there were 196 securities

listed on the DSE with a total paid-up capital of about Taka 4 billion and the

daily average transaction of shares during that period was about 20,000

(Basher, Hassan and Islam 2007). Trading activity of the Exchange remained

suspended since the start of the war of liberation in 1971 until it restarted in

1976. When the DSE restarted in 1976, the DSE had only 9 listed companies

with a paid-up capital of approximately Taka 137.52 million and at the end of

that year total market capitalization of listed securities was about Taka 146.73

million. By 2002-03, the number of listed companies has grown to 251companies listed with the DSE having total issued capital of Taka 35,537

million (US$ 612 million) and total market capitalization of Taka 72,167

million (US$ 1,244 million). In 2008, the number of listed companies is about

295 with a market capitalization of about US$ 7,067 million.

The second stock exchange, the Chittagong Stock Exchange (CSE) was

established in 1995 and started its operation in that year with 30 listed

securities. Like the DSE, the CSE has been registered as a public limited

company and is a self-regulated non-profit organization. It has currently 129members even though there is a provision for up to 500 memberships. The




were 187 listed securities with the CSE. On the same day, the total issued

capital and market capitalization of all listed securities with the CSE stood at

Taka 33,085 million (US$ 570 million) and Taka 59,855 million (US$ 1,032

million), respectively.

In terms of regulatory structure, the capital markets of Bangladesh received its

first legal backing with the passage of Securities and Exchange Ordinance in

1969. More than two decades later, in 1993, the Securities and Exchange

Commission (SEC) was established under the Securities and Exchange Act,

1993. The functions of the SEC include regulation of equity trading, protection

of investors, ensure legislative and regulatory compliances, and promote a fair,

transparent and efficient security markets. To supervise and regulate the

activities of the capital markets in Bangladesh, the SEC does it by performingconstant real time monitoring and post-trading analysis of transactions in the

DSE and the CSE.

The underdeveloped and non-transparent nature of the capital market in

Bangladesh provides ample opportunities for unethical and even illegal

manipulations resulting in market crashes as happened in 1996 (as reflected by

a steep decline of the market capitalization value in US$ shown in Figure 1

below). Such unwarranted crashes usually cause severe financial damages to

investors, particularly many small investors and erode confidence in the

markets. This painful episode occurred at both stock exchanges in summer and

fall of 1996. During this episode, DSE index increased from 832 in January

1996 to its peak at 3,567 on November 14, 1996 and back down to 507.33 in

November 1999. To control the damages caused by the 1996 crash and with the

support from Asia Development Bank (ADB), Bangladesh government

introduced the Capital Market Development Program in November 20, 1997

with several objectives such as to (i) strengthen market regulation and

supervision, (ii) develop the stock market infrastructure, (iii) modernize stock market support facilities, (iv) increase the limited supply of securities in the

market, (v) develop institutional sources of demand for securities in the market,

and (vi) improve policy coordination.

Ali and Wise (2007) argued that Bangladesh capital market is not yet well-

developed. Figure 1 shows the time trend of the number of listed companies

along with the market capitalization in US$ from 1988 to 2008. This graph

suggests that the stock market has grown rapidly from 101 companies with a

market capitalization of US$ 430 million in 1988 to 295 companies withmarket capitalization of US$ 7,067 million in 2009, an impressive growth rate




GDP is still quite low compared to international standard.

Figure 1: Listed companies and Market Capitalization in Bangladesh: 1988-2009

8.E+09 Left Scale: Market Cap Value US$ 300 Right Scale: No. of Listed Companies 250

6.E+09 No. of Listed Companies 200

4.E+09 150

2.E+09 100

Market Cap Value (US$) 50 0.E+00

88 90 92 94 96 98 00 02 04 06 08 10 Year Source: World Bank: World Development Indicators CD Rom database

The market capitalization as the percentage of GDP increased from 1.68% in

1988 to about 8.39% in 2008, also an impressive growth. But this rate for

Bangladesh (BGD) compares quite poorly compared to India (IND), Pakistan

(PAK), and South Asia (SAS) as shown in Figure 2, which shows BGD line is

at the bottom of Figure 2 below the other reference countries. In fact, the ratio

for India and South Asia reached around 150% and 125% of GDP respectively

in 2007, just before the crash of the markets due to the 2007-09 global financial

crisis. It is worth noting that the Bangladesh capital market showed resilience

in the face of this massive crisis. However, given the relatively low market

capitalization-GDP ratio of 8.39% in 2008, it appears that Bangladesh capital

market needs much more development in order to catch up even with its

comparable neighboring countries.

Figure 2: Market Capitalization as % of GDP: 1988-2009

160 % of GDP

Market Cap as % of GDP IND

120

80 SAS

40 PAK

0 BGD 08 10

Year 88 90 92 94 96 98 00 02 04 06 Source: World Bank: World Development Indicators CD Rom Database




As to the relationship between Bangladesh money supply and the share price index,

Figure 3 shows the two monthly percentage changes in the stock price index narrow

money supply from 1999.01 to 2010.01. This Figure shows that both series has displayed

significant month to month fluctuations. Further, the apparent synchronized co-

movement of the two series gives preliminary indications that the two series would likely be co-integrated.

Figure 3: Relations between Changes in Money Supply and Share Price Index: 1999.01-2010.01

% SPt: % Change in Share Price Index (Right Scale) 30 20 10 0

12 -10 8 -20 4 -30 0

-4 MSt: % Change in M1 (Left Scale)

-8 99 00 01 02 03 04 05 06 07 08 09

Month / Year

Source: Data obtained from International Financial Statistics databas

As to the long-run relationship, empirical studies confirm the co-integration relationship

between the stock price index and the narrowly defined money supply. In fact their co-

integrating relationships are asymmetric. This asymmetric relationship indicates that the

counter cyclical monetary policies affect the cost to raise new financial resources of

corporations differently in different phases of business cycles in the long-run. More

specifically, the results reveal that the stock price adjusts more slowly to the threshold

value when the Bangladeshi monetary authority eases the money supply than when the

Bangladeshi monetary authority tightens the monetary policy. These findings suggest that

the stock price is more responsive to signals of possible contractionary monetary policy

as reflected in the decline money supply M1. These in turn indicate that equity (debt)-

market-dependent firms are more vulnerable to business cycle fluctuations (at least in

regard to their cost of capital) than firms with access to other sources of financing. Thus,

policymakers should be aware that counter-cyclical monetary policy may have different

effects due to the asymmetric behavior of stock prices in their formulation of monetary

policy.




Further, in a recent article, I found that due to the common characteristics associated with

poor developing countries, their equity markets are not even weakly efficient. This is not

viewed positively given that most well developed countries have efficient equity markets.

This observation coupled with the status of a poor developing country and their attendant

problems suggest that to develop an efficient equity market, Bangladesh should firstconcentrate its efforts on developing better market infrastructures for a more effective

market economy. In this environment, a strong political will to reform the system and a

strong commitment to implement the reforms are needed to establish a more competitive

and efficient overall market economy that would be conducive for building an efficient

stock market.

With regard to the short-run relationship, empirical studies further reveal that the short-

run counter-cyclical monetary policy is ineffective in stimulating or cooling down theequity market i.e., the stock price responds to monetary policy action in the long-run but

not in the short run. These empirical result suggest the lack of central bank creditability,

i.e., investors do not believe that central bank can carry out its policy objectives; thus,

they wait and see. The Bangladesh Bank (Central Bank of Bangladesh) may have

personally persuaded the commercial bankers to change their rate setting behavior

because there are few of them, and there may be some incentives for banks to listen. The

Bangladesh Bank authority cannot utilize the same tactic to deal with investors because

there are more of them and they may not have any incentive to listen.

Further, there are many allegations of insider trading, market manipulation, and

corruption in the equity market, leading to demonstrations by investors in the country on

a number of occasions, eroding confidence in the equity market. Unfortunately, neither

the government including the Securities and Exchange Commission, nor any regulatory

authorities including the Bangladesh Bank had taken serious steps to deal with these

allegations in a serious and effective manner to restore investor confidence in an already

small and unstable market environment.




4.0 Challenges

With regard to the Bangladeshi corrupted business environment and for whatever it is

worth, the Transparency International (2009, 2008, and 2007) ranked Bangladesh as the147th, 147th, and 162th, most corrupted country out of 180 nations that it studies, 1st

being the least corrupted. Moreover it is reported that 75% of the unethical practices in

the banking sector are attributable to the personal gain motivation, 20% due to the

business interest of banks such as charging high interest rates in the call money market or

discrimination of charging commission or service charges from one customer to another.

Only 5% of unethical practices are attributable to social reasons such as waiver of interest

up to Tk. 10,000 against agricultural loans. Though this waiver is done due to the

Government decision, it creates inequality among those persons who have taken loans.

When such waiver is made, those who are not benefited get jealous and their interest isnot protected. Moreover, when big defaulters get a lump sum amount of waiver for

rescheduling, those who are regularly paying interest think that they are being deprived!

One of the consequences of corruption is that the pervasive default culture in the

Bangladeshi economy, as evidenced by huge amount of nonperforming loans, which

prevented reductions in loan pricing. This is because cost of funds is high. Through moral

suasion, Bangladesh Bank has been requesting reduction in lending-deposit rate spread in

veil because with the exception of few public banks, other banks want to earn “super normal profits” resulting in high lending rates. Lack of ethics in the banking sector is a

part of wider and long lasting socio-economic and political problems in the country.

Loopholes in the banking sector are a part of the overall corruption that plagued almost

all segments in the country. There is a dilemma between the making money and business

ethics. Corruption is the buyer-seller collusion resulting higher business cost structures

and raising simulated shortage of funds in general, and in the banking sector, in

particular.

As a direct the consequence of extensive government interventions in the form of licensesand permits as well as directives, the ownership of private institutions and management

and control of public institutions are given to a few interests (individuals or businesses)

who are well-connected politically, explicitly or implicitly resulting in monopoly and

oligopoly type behavior in the banking and financial system. The monopolistic and

oligopolistic market structures coupled with the political connections of a few powerful




individuals and corruptions would invariably lead to cartels and price fixings. These

factors would hinder the effectiveness of national economic policy actions and result in

asymmetric adjustment in product and service pricing, and an unfair distribution of

national income in favor of the few. Naturally, these above-mentioned phenomena would

likely result in higher lending rates, lower deposit rates and hence higher lending-depositrate spread as well as predatory pricing behavior in the banking industry.

Customarily, originating loans would provide some non-interest incomes besides the

interest incomes to the originating institutions in any economic environment. However, in

a fairly corrupted environment, there may be some “other benefits” for both the

originating institutions and possibly their management as well. Naturally, it is easier to

ask for and the borrowers are more likely to agree to providing “other benefits” in the

declining lending rate environment than when the rate is rising. Certainly, a decline in

deposit rate widens the spread, which allows lending institutions to originate loans atlower lending rate and still maintain the old spread. This coupled with the high elasticity

of demand precipitate a significant increase in demand for loans, which in turn will create

opportunities for lending institutions and their management to generate lucrative “other

benefits” and hence the observed quicker responses. Asymmetrically, in the rising rate

environment, the new loans must be generated at higher lending rate and the possibly

negative attendant impacts on “other benefits” do not provide attractive opportunities for

lending institutions and their management, and hence the observed slower responses. As

aforementioned, Bangladeshi banking industry is operating in the high rate, corrupted

environment, when deposit rate changes causing changes in the spread, lendinginstitutions must weigh the marginal non- interest benefits to both the originating

institutions and their management against marginal loss in interest income in originating

new loans at the new lending rate to restore the spread to the threshold. This benefit

maximizing process in the face of highly elasticity of demand for loans precipitated by

high rate environment would be a very plausible explanation of the empirical findings of

the above pattern of the asymmetric adjustment process in the Bangladeshi banking

industry.

Another challenge for the banking industry in the country is with electronic banking such




as online banking. This system was introduced since 2009, although online banking has

bright prospects, it involves some serious financial risks. The major risk of online

banking includes operational risks (e.g. security risks, system design, implementation and

maintenance risks); customer misuse of products and services risks; legal risks (e.g.

without proper legal support, money laundering may be influenced); strategic risks;reputation risks (e.g. in case the bank fails to provide secure and trouble free e-banking

services, this will cause reputation risk); credit risks; market risks; and liquidity risks.

Therefore, identification of relevant risks, and formulation and implementation of proper

risk management policies and strategy formulations and implementations are important

for the scheduled banks while conducting online banking system.

It is theoretically well articulated and supported by empirical studies that investment in

physical capital or otherwise is inversely related to the level of market interest rates.

Moreover, the positive relationships between investments and economic growth as wellas social progress are well established. National economic policy consists of three

components: Monetary policy, fiscal policy and exchange rate policy. These three

policies must be coordinated to achieve overall economic goals because their adjustment

processes operate in different time frames. To this end, whatever reasons causing high

market rates would definitely hinder the economic growth, industrialization, as well as

social progress of the country. Bangladesh is, no doubt, one of the vivid examples of

these phenomena in the world! It is a very difficult to address these issues using only one

component without free market disciplines! Bangladeshi banking sector has gone through

several restructuring and reforms, but cannot overcome any of these problems. The mainreason is the nexus between bureaucrats, politicians, civilians, bankers. They are playing

prisoner's dilemma game whose winning strategy is not to disclose the corruption but to

participate in the process. Moreover, exchange rate is being manipulated in favor of a

group of business magnets and remittance senders to Bangladesh to give them special

privilege. How else can the fact of slow economic development, industrialization, and

social progress in the last 41 years, including perennial banking sector problems be

explained?

Not only Pareto optimality theory but even the theory of second best cannot be applied in




the economy as alternative funding sources from the non-government organizations are

also charging too high interest rates. The effective interest rate charged by the four largest

micro-credit institutions are the Grameen Bank, which charges around 30.5%, the BRAC

at 44.8%, ASA at 44.8%, and the PROSHIKA charging at around 42.3%. Through Micro

credit regulatory agency, the current government did set the ceiling interest rate in case of NGOs at 27% which is still relatively high. Moreover, starting from the Grameen Bank

(which is a statutory institution) and some big NGOs have a number of other types of

business for stated social development purposes in the informal sector. However, these

activities of these micro credit agencies are not currently regulated, but needs to be

supervised and regulated as well. It is not understandable why the micro credit regulatory

agency doesn‟t look after these businesses.

5.0 Discussions and Conclusions

Clearly, the root causes of the Bangladeshi financial sector problem are the lack of

market discipline due to lack of competition in the banking industry. Excessive

government intervention and political connections, economic and political corruptions,

operational and managerial inefficiency and ineffectiveness result in vicious circle that

inhibits economic development, industrialization, and social progresses in poor anddeveloping countries in general and in Bangladesh in particular. The desired

characteristics of the economy have been elusive for Bangladesh due to the political will,

or lack thereof. The competitiveness and the transparency of the market economy will

reduce the lending-deposit rate spread. These cannot be achieved in the absence of the

infrastructure of a well-functioning market economy. Bangladesh bank recently decides

to give permission to open more new banks. This may bring fruitful results if it can be

properly handled to mobilize savings and channel those into productive sectors. Besides,

loans obtained by the government from the banking sector seems to overburden the

banking system and may be a cause of crowding out private investment. BangladeshBank seems to even fail in its primary function of price stabilization with current inflation

creeping into a rate around 8.126% per year (source: International Monetary Fund - 2011

World Economic Outlook).As a resultant factor purchasing power of the people of the

country has declined. Moreover, the capital market, especially share market should be

more properly regulated and try deal with the perennial problem of corruption, insider




trading, and market manipulation by selected but powerful and politically well-connected

few elites.

With a market economy structure, the following changes will significantly improve the

financial sector, economic growth, industrialization, and social progress in Bangladesh.But first and foremost is still the free market discipline, provided by the free market

economy subject to prudent regulation and oversight, and not excessive government

direct interventions. Micro credit regulatory agency may be redesigned and renamed and

it should take steps for regulating both lending as well as social businesses of NGOs as

well as the Grameen Bank. Otherwise it will be difficult for reducing poverty in the rural

areas and improving women empowerment.

In a well-functioning market economy, financial business and management of bank and

non-bank intermediaries would likely be more efficient; otherwise, they would beeliminated from the market place. Undesirable phenomena such as unethical behavior,

crimes and irregularities like money laundering, black-marketeering, undue profiteering

and loan defaulting are fairly easy to detect (sooner or later) and rectify by effective rules,

regulations and supervision in a market economy. Additionally, sound financial business

can be established so that financial sector can be free from all sorts of political

interference. Political pressure for disbursing loans and prohibiting against those who

create scam in the capital markets in 2010-11 and several other times should be stopped

and legal actions against perpetrators should be taken without any sort of prejudice.

Defaulters as well as market manipulators would be disciplined. Investment Corporationof Bangladesh should be reactivated and the DSE and the CSE should be strengthening

by improved corporate governance.

Additionally as to the personnel, code of conduct, audit and monitoring systems, de-

politicizing the process of appointment of the directors to curb their excessive power to

sanction loans and advances can be established to assure efficiency and effectiveness.

Manpower planning process can be established in the banking industry to improve

productive human resources to prepare the sector for the global challenges. In the

financial sector an ombudsman may be appointed. The ombudsman can actindependently to investigate any complaints regarding financial services and must work

freely and independently. Better financial services and diversified financial products

would be the natural consequence of competitive financial industry. Operational and

administrative expenditures may be reduced through implementing contemporary

financial and competent management structure. Improved customer relationship




management system to retain existing customers of the financial institutions can be

established in a market economy. If the above measures are carried out and implemented

along with strengthened regulatory environment and additional much needed financial

sector reforms, a better and more efficient financial sector may evolve over time and

serve better the development needs of the country.

change in financial sector of bangladesh

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