The world is yet to recover from the Financial Crisis of 2007. Banks world over collapsed in a heap. Greece, as a country was the centerpiece of loss of public trust in the banking system’s ability to serve the interests of the depositors, investors, the general public and the real economy. Its external debt to the EU had to be rescheduled several times which sparked widespread uproar and triggered the collapse of three governments.

2. Spain is also yet to fully recover from the aftermath of the bubble burst in the Real Estate Sector. Despite its size, the Italian economy also remains edgy. Iceland and Britain also had their fair share of woes.

3. Aggressive lending practices in the US sub-prime mortgage market and lax regulation of the financial sector were at the root of the crisis which had contagion effects not only on the real sector of the US economy but also on financial and real sectors of the global economy, posing very serious problems for economic activities.

4. The coming years 2016 and onwards will continue to witness and suffer from the economic turmoil already set in motion. Small economies like ours are not immune to global fallouts of global downturns or negative spillovers from larger economies and as such have strong stake in global stability and economic growth.

5. Whilst it is important to minimize the adverse impact of the external shocks, those of the internal ones cannot be overlooked either. The recent financial scams of Hallmark, Destiny and Bismillah groups in Bangladesh brought to light laxity in Bank Management. The serious fraud started mainly in the state-owned commercial banks. From the Board of Directors down to the lower level management officials, these banks have not shown any sign of good governance, transparency and accountability. Worse still, these irregularities have permeated to private commercial banks.

6. These state-owned and private banks though may differ slightly in governing structure but by and large follow the operational guidelines of the Bangladesh Bank. These guidelines are prudent, well formulated and conform to international standards.

7. The International Accounting Services Board (IASB) under the Bank for International Settlement (BIS), Basel, Switzerland, has provided three major norms, namely:

Basel I of 1988

Basel II of 2004

Basel III of 2014

8. Basel I 1988 requires that banks and financial institutions have sufficient capital adequacy, which was originally 8% of Risk Weighted Assets (RWA). Later on, it was raised to 10% for banks, including those in Bangladesh. There are some banks in Bangladesh whose required capital adequacy falls short of the norm. Basel I set up a mechanical, non-market oriented measurement of capital adequacy which could not take care of fundamental risks, e.g. operational risk and market risk. Basel II took care of the different types of risk for financial intermediaries (i.e. banks) as well as the supervisory review process for the management of banks. The global community realized the inadequacies of Basel I and Basel II during the recent financial crisis of 2007. Basel III was introduced in 2014 and is supposed to be completed in 2019. The major aspects of Basel III are: first, to strengthen the capital framework of banks and to give more emphasis on equity capital (Tier-1, core capital); second, to ensure global liquidity; third, to highlight systematic risks as well as mitigation measures that address the risks. Two major aspects regarding liquidity are Liquidity Coverage Ratio (LCR) and Net Stable Funding Ration (NSFR). Bangladesh Bank has recently issued a circular to implement Basel III liquidity ratios. Besides the three international Basel norms discussed above, banks follow other guidelines prescribed in various Acts and regulations in their respective countries.

9. Financial reporting by banks is very important in ensuring the interest of the depositors as well as that of the clients. The regulatory requirements of banks follow international standards.  The Bank Company Act of 1991 provides guidelines for preparation of reports including audit reports. On top of it, the state-owned commercial banks and specialized banks, like the Krishi Bank (RAKAB) are supposed to adhere to the provisions/requirements laid down in the respective Acts through which they were established.

10. The Registrar of the Joint Stock Company (RJSC) also has certain rules for entities registered under the Company Act and the Societies Registration Act. Similarly, Bangladesh Security Exchange Commission (BSEC) has laid down rules for companies to prepare their financial reports. On the whole, requirements for the financial reports of banks, non-bank financial institutions (regulated under the Financial Institution Act) and various companies are quite satisfactory in Bangladesh. The disturbing part is that these requirements are not properly complied with by various institutions.

11. Despite supervision and monitoring by the regulatory bodies such as Bangladesh Bank and BSEC, serious mismanagement and malpractices have occurred in the banking sector as well as in the capital market. The disclosure of banks in their financial reports is prepared by following International Accounting Standards-30 (IAS-30). This has been replaced by International Financial Reporting Standards (IFRS-7). According to this format the financial disclosure is more logical, which means that banks now face higher risk in the investment and management of capital. If the required standard is followed then depositors and clients of the bank and the general people will not face any loss. Besides IAS-30, there are also IAS-32, IAS-39 and IFRS -9, which are prescribed for the management, supervision, and monitoring of financial intermediaries. The government of Bangladesh took an initiative in 2001 to promulgate the Financial Reporting Act. In 2013, a draft was circulated to the main stakeholders the Institute of Chartered Accountants in Bangladesh (ICAB) and the Institute of Cost and Management Accountant in Bangladesh (ICMA). The Financial Reporting Act was promulgated by the government in 2014. We expect that this will be an effective and productive organization, and not a mere “white elephant” like many other institutions in Bangladesh.

12. It must be pointed out that a balance must be made between the regulation and independence of a bank. This means that banks should neither be overregulated nor should they be left alone to enjoy complete freedom, which often results in banking disasters. This point has been very aptly articulated by Jean Tirole, the Nobel Prize winner of Economics in a book jointly written with his colleagues. It is important to keep in mind what financial regulation is meant to achieve. The most important objective is to safeguard depositors, investors, other clients and stakeholders, and the real economy (real goods and services) as a whole.

13. The newly independent Bangladesh faced formidable challenges in the initial years in reforming the banking sector to revamp the economy. Loan recovery was extremely poor, enterprises were experiencing gross mismanagement, financial markets and institutions were unable to reach their commercial goals. In order to identify the major problems in the financial system, and to suggest remedial measures, the Government formed the “National Commission on Money, Banking and Credit (NCMBC)” in 1986. The Financial Sector Reform Program (FSRP) was launched in 1990, financed by the World Bank and USAID. The IMF provided the technical assistance. FSRP was instituted basically to make NCBs commercially viable for privatization, and to help the PCBs to increase their market share.

14. During the tenure of the program, the FSRP consultants provided extensive training to a large number of bank officials on tools and techniques. These tools dealt with how to:

• To analyzing the risk associated with lending

• To introduce ledger card while sanctioning new loans

• To report any loan of exceptionally large monitory amount

• To evaluate individual officials’ performance

• To supervise and inspect the banks effectively

• To use the MIS (Management Information System) effectively and efficiently

15. Bangladeshi banking sector reforms can be broadly split into Policy Reforms, Institutional Reforms, and Legal Reforms. These reforms cover:

Policy Reforms

• Risk-based Capital adequacy

• Loan Classification and Provisioning

• Credit Risk Grading

• Interest Rate Deregulation (Loan Pricing)

• Performance Planning System

Institutional Reforms

• Off-site Supervision (CAMELS Rating)

• Credit Information Bureau (CIB)

• Large Loan Reporting system (LLRS)

Legal Reforms

• The Banking Companies Act, 1991

• Artha Rin Adalat Act, 1990

• Bankruptcy Act, 1997

16. Establishment of Credit Information Bureau (CIB) was a landmark institutional reform. It stipulates that before considering any loan proposal, a bank has to know the status of the loan applicant in regard to his/her liabilities outstanding with any other banks/branches. Bangladesh Bank established the CIB in August 1992. CIB report is considered to be on the basic pieces of information for consideration of a loan. The aim of the report is also to avoid duplication of credit facilities, prevent extending credit facilities to defaulters, and to justify the status of the borrowers. It was made mandatory for all banks to collect and collate data from CIB before sanctioning any loan proposals (including SME loan) above Taka Fifty Thousand. Apart from this, to maintain records of borrowers’ performance, NCBs have to submit report to Bangladesh Bank regularly on their progress.

17. The measures taken so far are definitely not sufficient considering the gravity of the situation. Based on the above the following steps may need to be taken as reform or restructuring measures to speed up the process:

• The aim of any restructuring process is to attain solvency first. Though capital position of the banking system has improved slightly in recent years, yet most of the SCBs and DFIs, and a few PCBs are significantly undercapitalized. If injection of new capital is not possible then the banks should be allowed/motivated to raise new capital from the security market.

• Banking Sector Reforms must go in tandem non-financial institutions, insurance and capital markets. Banking Sector Reforms were undertaken time and again, but the measures have not been seriously implemented. What is of paramount importance here is political will and meaningful and concrete action.

• Non-performing loans should be focused exclusively in an efficient and productive way. Separate management within the same organization should be deployed to look after NPLs. The experiences of other countries with independent Asset Management Companies to deal with NPL may be assessed .

• The problem of excess liquid assets of the banks should be handled with due attention. In order to utilize the excess liquidity, efficient fund management should be exercised by the banks.

• Compliance with International Accounting Standards should be ensured in preparation of financial reports. Auditing of the particulars of financial statements should be done as per international standards for a transparent and proper disclosure of the financial strengths of the banks.

• Banks under Early Warning System have to prepare course of actions with individual deadlines to overcome specific problems. Bangladesh Bank has to deal with these banks properly and monitor progress closely.

• A number of measures were taken to strengthen the legal framework. However, in order to attain the benefit of improved legal framework, enforcement of legislations should be ensured. Legal procedures should be simplified, and disposal of cases should be speedier.

• Government interference, political involvement, pressure from trade unions has to be stopped for the smooth functioning of the banks.

• For developing the asset utilization ratio, portfolio of asset structure should be rearranged by removing the non-earning assets or transforming the non-earning assets into earning ones.

• Local commercial banks can also employ qualified and efficient employees with better compensation packages for achieving better output.

• Technological up-gradation of the banking system is needed, to equip it with state-of-the-art infrastructure and logistics.

• One of the major causes of the non-fulfillment of the entire objectives of the reform measures is the lack of proper and extensive training. Arrangement of large scale training program from both central bank and commercial banks is a must to get concrete results from the reform programs.

• Lastly, the problem of Bangladesh financial system is widespread and not related to banking system alone. Therefore the scope of the reform measures should also be applied to the non-bank financial institutions, for sustainable banking reform.