Indiscipline in the Financial Sector

The print and social media have been abuzz with concerns about indiscipline in the financial sector. The government has formed a banking commission to investigate the root causes of these issues and to propose strategies for overcoming this perennial problem. Recently, numerous individuals and forums have published articles and held workshops aimed at identifying the core issues facing the industry and recommending solutions to address its weaknesses.

Rather than reiterating the topics covered in these articles, I'd like to focus on a paper recently published by the CFA Society, which provides a commendable overview of key areas for reform. These include: the role of Bangladesh Bank, governance in the banking sector, management of non-performing loans (NPLs), strengthening the capital base, improving regulatory clarity and oversight, and reforming the business mindset of state-owned commercial banks.

With over 44 years of experience in the corporate sector, I am a firm believer in the 80/20 Pareto Principle, which suggests that 20% of the problems account for 80% of the negative outcomes. When considering the financial sector, the foremost issue is the glaring failure of Bangladesh Bank to regulate effectively. This failure stems largely from crony capitalism and personal gains, exacerbated by weak enforcement of regulations due to widespread corruption.

Bangladesh offers a prime example of a country with comprehensive laws in place, but where enforcement is severely lacking. Take traffic laws, for instance. In Bangladesh, they are routinely flouted because offenders are rarely held accountable. However, in countries where these laws are strictly enforced, people follow them scrupulously. The same analogy applies to the financial sector, where regulations either lack proper enforcement or are manipulated to benefit powerful business interests, leading to numerous banking and non-financial scandals.

Another pressing issue is the problem of willful defaulters who currently face no meaningful consequences for their actions. While the CFA Society has rightly recommended publishing the names of these defaulters, I believe we need to go further. Many borrowers have been observed diverting funds into personal luxuries—such as buying luxury cars, land, and property—or investing in the stock market, instead of using the loans for their intended purpose. Banks must proactively investigate such diversions and seize any assets purchased with misused funds. Additionally, willful defaulters should face restrictions, including travel bans without bank approval, prohibitions on staying in luxury hotels, and even limitations on their credit card usage. Unless such stringent measures are implemented, these defaulters will continue to abuse bank funds with impunity.

As a board member of a bank, I have seen firsthand some of the systemic weaknesses that plague the sector. One of the most concerning practices is "name lending," where loans are given based on well-known corporate entities rather than a thorough analysis of the borrower’s business model. As a result, insufficient attention is paid to financial statements and audit reports, both for clients and for the banks themselves. It’s common practice in Bangladesh to report profits even when a company has incurred losses, as banks are reluctant to lend to businesses that are losing money. This leads to the manipulation of financial ratios like the debt-to-equity ratio, where inflated profits boost equity to facilitate further lending. Simple financial indicators, such as the cash conversion cycle, can serve as red flags. In some cases, I have seen cycles as long as 220 days, a clear indication that the enterprise is unsustainable. This is a prime example of account fabrication. Furthermore, many struggling banks continue to receive unqualified audit opinions, masking their underlying problems.

Another major issue is the concentration risk that arises when banks rely too heavily on large depositors and borrowers. If a major depositor withdraws funds, the bank’s advance-to-deposit ratio can be thrown into disarray. Similarly, the current cap of 15% for funded and 20% for non-funded exposure to large borrowers amplifies the risk in case of default.

When banks take collateral, such as shares, land, or property, senior officials often fail to conduct physical inspections, which can lead to the acceptance of impaired collateral. I have seen instances where the borrower did not even possess the land or property in question, or where the value of the collateral was grossly inflated.

Bangladesh Bank conducts annual comprehensive audits of banks, but there have been reports of underreporting of provisions that the regulator has overlooked. In such cases, corruption or undue influence cannot be ruled out.

The new government now has a unique opportunity to clean up this "Augean stable." Reforming the financial sector is crucial, as it forms the backbone of any thriving economy. Without swift and decisive action, these problems will continue to undermine Bangladesh’s economic potential.

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