Examination Committee :

Dr. Sundar Venkatesh(Chairperson)Dr. Juthathip Jongwanich (Co-chair)

Dr. Yousre Badir ( Member)

Agenda of Presentation

Objectives

Data and Methodology

Risk Based Supervision

Supervision by Bangladesh Bank

Bank Failure Bank Failure

Effectiveness of BBs Supervision(Findings)

Recommendations

Objective

To study the present supervisory role of Bangladesh Bank (BB);

To review the supervisory methods used in developed (G-7) countries and Risk based supervision;countries and Risk based supervision;

To identify the causes of Bank Failure and its effect;

To analyze the effectiveness of BBs supervision in the Banking sector of Bangladesh;

Data & Methodology

Mainly secondary data

Data collected for period from 2004 to 2010

Various laws, rules, regulation and circulars relating to Bangladeshs banking sectorBangladeshs banking sector

Current Issues relating to international banking arena, international best practice such as Basel core principles and Risk based supervision

For data analysis-Trend and Time series data, ratio analysis and graphical presentation

Bank supervision in some developed countries and Risk

Based Supervision

Mainly group of seven (G-7) industrialized countries

In those countries-mainly off-site supervision

In those countries not only the Central Bank is the main In those countries not only the Central Bank is the main supervisor of banking sector but several other agencies such as Financial Services Authority and Ministry of Finance/Department of Treasury are also involved

Risk Based Supervision

A new era in banking supervision The Basel Core Principles for Effective Banking Supervision

(BCPs) also explicitly require banks to have comprehensive risk management process which is described in BCP No. 7Supervisors must be satisfied that banks and banking groups have in place a Comprehensive risk management process have in place a Comprehensive risk management process (including Board and senior management oversight) to identify, evaluate, monitor and control or mitigate all material risks and to assess their overall capital adequacy in relation to their risk profile.

Definition.. RBS may be defined as a supervisory approach that is designed to identify activities and practices of greater risk to the soundness of banks and accordingly deploying supervisory resources towards the assessment of how those risks are being managed by banks.

Benefits of RBS

cost-effective use of supervisory resources through a greater focus on risk, which in turn results in better use of bank resources;

a consistent framework for evaluating banks through the separate assessment inherent and risk management processes;processes;

early identification of emerging risks at individual banks and on a sectoral basis;

a better appreciation by supervisors of the characteristics of the banks' business, of the risks they face and of the quality of their management;

it helps instill into banks management the culture of risk management and oversight.

Traditional Vs. Risk Based Supervision

Traditional Approach Risk based ApproachTransaction based testing Process-orientedPoint-in-time assessment Continuous assessmentPoint-in-time assessment Continuous assessmentStandard procedures Risk profile driven proceduresHistorical performance Forward looking indicatorsFocus on risk avoidance Focus on risk mitigation

Bank Supervision by Bangladesh Bank

Bangladesh Bank, being central bank of Bangladesh, supervises banks and financial institutions

Legal framework in Article 7A(F) of Bangladesh Bank order,1972 and section 44 of Banking Company Act,1991

Off-site, On-site and surprise inspection (various dept of BB) Off-site, On-site and surprise inspection (various dept of BB)

CAMEL Rating from 1995

Issues rules and regulation time to time on need basis and in public interest

Introduce Stress Testing for Banks and FIS after the global financial crisis

Bank Supervision by Bangladesh Bank(Contd)

Started risk based supervision from 2005, frequency annually on credit risk, foreign exchange risk, asset liability management, information technology, anti money laundering risk and internal control and compliance risk

Currently traditional inspection and risk based inspection going on parallel, but more focus on risk based inspection going on parallel, but more focus on risk based inspection

Customer Interest Protection Center established where any individual can complain against banks and FIs by letter, phone, fax and e-mail. Recently 24 hour hotline installed in CIPC.

Bangladesh Bank has signed MOU with various countries for exchange of financial information regarding stolen or siphoned money.

Key Key Key Key eventseventseventsevents of bank supervision in Bangladesh (2000 of bank supervision in Bangladesh (2000 of bank supervision in Bangladesh (2000 of bank supervision in Bangladesh (2000 2010) 2010) 2010) 2010)

Loan right-off

Corporate governance in banks

Guideline for core risk areas

Risk based inspection or system audit

Credit risk grading manual

Limiting banks exposure to capital market Limiting banks exposure to capital market

Single borrower exposure limit fixed

Some amendment in Bank Company Act,1991

Money Laundering Prevention Act,2002

Terrorist Financing Act,2009

Risk Management Unit in all banks

Stress Testing

Establishing Complaint Cell in all Banks

Bank Failure : Cause and effect

(Literature Review)

Bank failure has occurred domestically and internationally In the wake of recent global financial crisis, bank failure has

also a concern for bank supervisors because some Too big too fail banks also collapsed

Definition. The financial institution was recapitalized Definition. The financial institution was recapitalized either by the central bank or an agency specifically created to address the crisis, and/or required a liquidity injection from the monetary authority; and The financial institutions operations were temporarily suspended (frozen) by the government; (Bongini, Claessens, and Ferri 2001; Gonzalez-Hermosillo 1999)

Causes of Failure

(Literature Review)

Government permeation of the banking system Poor management Excessive risk-taking Supervisory forbearance Supervisory forbearance Ineffective market discipline Supervision is not on a consolidated basis

Cass E. Brian (1998).Banking as facilitator of domestic andglobal economies: Basles Core Principles of effective Banking

Supervision: Maintaining the momentum,

Implication of failure

(Literature Review)

Failures have occurred causing losses to consumers, investorsand governments impending economic activity incommunities and sometimes threatening banking andeconomic losses internationally. (Nadler and Bergen 1933)

Failure has a negative impact upon growth of credit,government costs, capital accumulation, monetary policy andsystem liquidity.

domino effect of a single failure on several banks in othercountries may impair significant parts of the world economy.

How to ensure effective supervision

For supervision to be effective following preconditions areneeded :

In order to perform his job effectively and efficiently, asupervisor must have operational independence, the meansand powers to collect information both on-site and off-site andauthority to enforce them;authority to enforce them;

Close collaboration with other supervisors is essential, mostlywhere the operations of banking organizations run across thenational boundaries;

Supervisors must look into the fact that banks have sufficientresources including adequate capital, efficient managementand effective internal control system, because these should besound before going to take any risky venture;

How to ensure effective supervision ( Contd)

For effective banking supervision the risk profile ofindividual banks needs to be assessed and also supervisoryresources allocated accordingly;

exactly how much power supervisor has and how it uses itis equally important. First, the supervisory authority mustis equally important. First, the supervisory authority musthave powers that enable it to take prompt corrective actionwhen it observes deterioration in bank solvency levels, torestructure and reorganize a troubled bank and in extremecircumstances, declare a seriously troubled bank insolvent;Second, when violations in regulation and legalrequirements or imprudent behavior by banks are observed,the supervisory authority should have the discretion toaddress these issues; third, the supervisory authority shouldhave the power to act without undue involvement from thecourts.

Effectiveness of BBs Supervision/Findings

The banking sector of Bangladesh comprises 47 banks andaround 7000 bank branches. Bangladesh Bank performsupervisory function by its various departments. BangladeshBank is striving hard to promoting and maintainingsoundness, solvency and systematic stability of the financialsoundness, solvency and systematic stability of the financialsector as well as to protecting interest of depositors. Eventhough it cannot be firmly claim that all the improvementshave been made in the overall banking sector but significantimprovement are the result of central banks stringentsupervisory functions.

0

5

10

15

20

25

30

35

40

45

50

Per

cen

t

NPL to total loan by types of Banks

SCB

DFI

PCB

FCB

A Non-performing loan is either default or close of beingdefault. From the above diagram we can see that from 2004-2010 Non-Performing loans declining gradually due to rigorousmonitoring of Bangladesh Bank. Private commercial banks andForeign commercial banks have low level of NPL compared toState controlled banks and development financial institution.

2004 2005 2006 2007 2008 2009 2010

Year

0

5

10

15

20

25

Per

cen

t

Ratio of net NPL to Total loans by types of Banks

SCB

DFI

PCB

FCB

From the above diagram we see that the ratio of netNPL(net of provision and interest suspense) is 0 for privatecommercial banks and negative for foreign commercialbanks. And for state controlled banks and developmentfinancial institutions is declining considerably.

-5

0

2004 2005 2006 2007 2008 2009 2010

Year

20

40

60

80

100

120

Per

cen

t

Provision maintenance ratio All Banks

Provision maintenance ratio

Provision maintenance ratio is also increasing for theperiod (2004-2010). Provision maintenance ratio isprovision maintained divided by required provision . Herewe also see that provision maintenance ratio of all types ofbanks in Bangladesh are increasing.

0

2004 2005 2006 2007 2008 2009 2010

Year

0

10

20

30

40

50

60

70

80

90

Per

cen

t

Net Interest Income by Types of Banks

SCB

DFI

PCB

FCB

Net interest income (NII) by all types of banks inBangladesh is rising for the period (2004-2010). NetInterest Income is the difference between the revenue thatis generated from banks assets and the expensesassociated with its liabilities. Private commercial banksNII is highest.

-10

0

2004 2005 2006 2007 2008 2009 2010

Year

-150

-100

-50

0

50

2004 2005 2006 2007 2008 2009 2010

Return on equity by types of Banks

SCB

DFI

PCB

FCB

Return On Equity (RoE) is net income after tax divided byshareholders equity. It measures banks efficiency at generatingprofit from every unit of shareholders equity. It shows how well abank uses investment funds to generate earning growth. Here wecan see steady growth of RoE for PCBs, FCBs and SCBs in(2004-2010) except for DFIs.

-200

0

0.5

1

1.5

2

2.5

3

3.5

Return on assets By Types of Banks

SCB

DFI

PCB

FCB

Return on Assets (RoA) is net income divided by total asset. RoAgives idea as to how efficient management is at using its assets togenerate earnings. Here we can see RoA of SCBs and PCBsincreased for the period (2004-2010) with exception to DFIs andFCBs.

-1

-0.5

0

2004 2005 2006 2007 2008 2009 2010

0

20

40

60

80

100

120

Per

cen

t

Expenditure income ratio by types of bank

SCB

DFI

PCB

FCB

Banks are able to reduce the expenditure incomeratio during the period (2004-2010). It is one ofthe indicator of management efficiency. From theabove diagram we can see that expenditure incomeratio is gradually reducing by all types of banks.

0

2004 2005 2006 2007 2008 2009 2010

Year

Problem bank scenario in Bangladesh has also witnessed asignificant improvement. When Bangladesh Bankintroduced problem bank system in 1994 there were initiallyseven banks. Due to Bangladesh Banks continuousmonitoring and supervision all seven banks were able tocome out from it before 2005. BB introduced Early Warningcome out from it before 2005. BB introduced Early WarningSystem (EWS) of supervision from March 2005 to addressthe difficulties faced by the banks in any of the areas ofCAMELS. Any bank found to have faced difficulty in anyareas of operation, is brought under early warning categoryand monitored very closely to help improve its performance.Presently 2 banks are monitored under EWS.

Conclusion and recommendations

Bangladesh Bank is not enjoying the autonomy to its fullestextent. It is very much essential for a central bank to regulatethe scheduled/listed banks stringently. So necessary stepsshould be taken for greater autonomy of Bangladesh Bank. Ifneeded, appropriate amendments in Bangladesh BankOrder,1972 are required.Order,1972 are required.

Strict enforcement of policies should be made by the Bangladesh Bank to ensure that no banks, especially private commercial banks, relax credit standards on insider loans and make such loans on preferential terms.

Conclusion and recommendations ( Contd)

Risk Based Supervision (RBS) is getting priority in developedcountries for its logical superiority. Because one of the keyissues of bank supervision is to keep the risks under control orat a minimum level which is the main focus of Risk BasedSupervision. Bangladesh bank should try to adopt this systemof bank supervision as its main supervisory weapon.of bank supervision as its main supervisory weapon.

Bangladesh Banks supervision departments are required totake steps for further strengthening the on-site inspection.More and more manpower are needed in these departments asbanks network (branch) are ever increasing. Also proper andup to date training are needed for the bank supervisors.

Conclusion and recommendations( Contd.)

Present banking laws have ineffective and loandefaulters are taking full advantage of this weakness.So it is the crying need of the hour to make suitableamendments to the Artho Rin Adalot Ain,1990.

World in now a global village. Capital movements World in now a global village. Capital movementshave increased more under foreign direct investmentand Public Private Partnership. More multinationalcorporations are coming to our country. So foreignexchange transaction has increased manifold. Soproper amendment in the Foreign ExchangeRegulation Act, 1947 is needed to regulate foreignexchange transactions.