Professional Documents
Culture Documents
The Perspective of Loan Default Problems of The Commercial Banking Sector of Bangladesh: A Closer Look Into The Key Contributory Factors
The Perspective of Loan Default Problems of The Commercial Banking Sector of Bangladesh: A Closer Look Into The Key Contributory Factors
net/publication/325692505
CITATIONS READS
4 4,820
2 authors:
Some of the authors of this publication are also working on these related projects:
All content following this page was uploaded by Bablu Kumar Dhar on 11 June 2018.
Rupam Chowdhury *
Bablu Kumar Dhar
ABSTRACT
This paper seeks to examine the relationship between several contributory factors and loan default
problems of both the State-Owned Commercial Banks (SCBs) and Private Commercial Banks (PCBs) of
Bangladesh. The key factors that have been enduring the credit problem (i.e. non-performing loans)
were reviewed rigorously. Contributory factors such as: corporate governance, credit management,
credit regulations, and the degree of political interference were identified. Findings indicate that the
credit operations and performances of private commercial Banks have outperformed those of state-
owned commercial banks. The loan disbursement approaches of state-owned commercial banks were
not efficient enough to achieve required recovery target. Furthermore, it has also been found that the
state-owned commercial banks are more likely to be affected by each of the contributory factors far
more adversely than private commercial banks. Effective use of corporate governance, keeping
transparency and accountability in all respect, efficient credit risk management, enhancing managerial
efficiency, successful privatization, lessening political interference and adapting modern technological
changes, may improve the overall loan problem scenario of state-owned commercial banking sector of
Bangladesh.
INTRODUCTION
The banking sector of Bangladesh has been witnessing a significant level of changes after being
dealt with a rigorous financial reformations and liberalization, which was inaugurated in 1992.
The main purpose of these programs was to make the whole financial system smooth,
competitive and efficient for achieving much confidence to meet the intense challenges of twenty
first century. The result of that initiative has not only, made the financial sector strong and
competitive but also, increased the adaptability for the contemporary changes.
* For correspondence: Rupam Chowdhury, Lecturer, University of Science and Technology Chittagong
(USTC), Bangladesh.
Email: rupamchy2007@yahoo.co.uk
University of Science and Technology Annual (USTA)
Nevertheless, some adverse contributory factors are still yet to vanish from banking operations
and have been impacting the whole credit operations of the commercial banking sector of
Bangladesh adversely. Due to satisfactory level of good governance practices, Bangladesh’s
economy has been performing a very promising role over the last few years in comparison with
other neighboring countries in South Asian region. In the fiscal year of 2011 GDP growth rate of
Bangladesh was 6.7% which is third highest growth rate among neighboring countries- Sri Lanka
with 8.3%; India 6.9%; Nepal 3.9%; Pakistan 2.4%. Evidently, the constant improvement of the
service sector’s health in Bangladesh has not only compensated the fading agricultural sector but
also, has initiated a true dynamic pace to the country’s national economy. In the financial year
of 2010-2011, the service sector of Bangladesh alone contributed more than 23% of GDP
(Bangladesh Bank, 2011). Financial Intermediaries (Bank, Insurance company, Mortgage etc),
are the key participant has gained a significant growth of 9.39% and contributed a very important
portion of 0.94% in GDP of 2011. It is to be mentioned here that, the present growth in the
financial intermediation is the reflection of positive and healthy movement of the commercial
banking sector of Bangladesh. Ahmad and Khanal (2007) argued that this promising economic
movement is the outcome of successful operations of PCBs of Bangladesh even though, the
major share of which are controlled by SCBs. Private commercial banks in Bangladesh have
been appeared as the most potential business sector over last few decades. Privately held
commercial banks have recently outperformed the nationalized banking sector in different sides.
According to the Bangladesh Bank (2011) the privately owned banks holding about 61.4% of
total deposit (i.e. BDT 2505.9 billion of total deposit of BDT 4082.7 billion), comparing
nationalized bank’s 27.5% (i.e. BDT 1123.6 billion of total deposit of BDT 4082.7 billion) and
PCB’s 59% of total assets (that is, BDT 3205.4 billions of total assets BDT 5431.5 billion) as
compared to SCB’s 28.8% of total assets (i.e. BDT 1564.9 billion of total asset BDT 5431.5
billion). The number of privately owned commercial bank stood at 30 with 2912 branches all
over the country in comparison with 4 nationalized commercial banks with 4148 branches
(Bangladesh Bank, 2011).It can also be observed in different reports that, the privately held
commercial banks have been maintaining a healthy loan recovery rate, which is well above the
rate maintained by the public commercial bank. Bangladesh Bank, Quarterly (2010) showing the
loan recovery rate of privately owned banks has increased considerably by 42.7% while the
recovery rate of public commercial banks has increased only 15.6% over the last few years.
Private commercial banks recovered BDT 56 billion, where publicly owned banks could able to
recover BDT 17.5 billion outstanding. Loan recovery comparison of the two banking sectors
portrays the disappointing scenarios of SCBs and also shows PCBs with non-performing loans
i.e. 3.5% as compared to SCBs’ 14.1% (Bangladesh Bank, 2011). Nevertheless, the contributions
of SCBs are not negligible, rather, because of its several roles like: large geographical coverage,
effective mobilization of fund throughout the country, huge employability, good motivation for
small and large deposit, immense rural eco-social development program, provides an extra height
to this banking sector (Chowdhury, 2002a).
University of Science and Technology Annual (USTA)
2: LITERATURE REVIEW
2.1: LOAN DEFAULT ISSUES AND THE KEY CONTRIBUTORY FACTORS
The success of a commercial banking sector mainly depends upon an effective loan disbursement
and loan recovery approaches. Loan or credit is not only the profit making assets for a
commercial bank but also, a great source of risk (Chowdhury, 2002). As a result, all banks
always do care about maintaining an optimum balance between return and risk, which is
associated with each loan portfolio. Therefore, disbursing loan to the right party and recovering
that loan in right time is very crucial for every commercial bank. If bank failed to assess the risk
associated with the proposed project, may linger loan payback period which in turn hamper the
frequent use of bank’s funds and the liquidity thereby (Bloem and Gorter, 2001). Furthermore,
the national economy will not achieve any benefits originated from the bank’s credit grant until
and unless new loan and borrowers are encouraged (Heffernan, 2005; Paul, 2007). Huge default
loan is one of the major problems for the commercial banking sector of Bangladesh and this has
University of Science and Technology Annual (USTA)
been pushing the whole sector to the verge of collapse. Podder and Mamun (2004) mentioned the
on-going high NPL could impact whole economic progress harshly. Evidence shows that the
loan recovery rate of Private commercial banks is much higher than the loan recovery rate of
nationalized commercial banks. At this moment, need for the improvement of such factors as:
corporate governance, credit management system, managerial efficiency, rules and regulation
have become obvious (Podder and Mamun, 2004; Chowdhury, 2002 b). The banking sector of
Bangladesh is dominated by commercial banking organization. With huge bad debt burdens
because of such factors like: poor credit classification, inefficient extension, administration and
preferential loan sanctioning (Siddiqui and Podder, 2002). There are some other underlying
factors that are responsible for that bulk loan default. Choudhury and Raihan (2000) observed,
most of the credits are distributed by undue influence of government body which, in turn become
bad loan. Furthermore, inappropriate loan classification, provisioning, accounting procedures
and weak legal and judiciary structure have made the whole situation even worse (Rehman,
2000). Reaz and Arun (2006) have also identified the following factors like: undisciplined credit
management, constant increasing non-performing assets, lack of provisioning, capital deficit,
corruption sheltered by political group, poor loan recovery, poor asset quality, weak bank
management, extreme intervention from government, weak supervisory and regulatory role of
associated parties etc. are mainly responsible for poor credit performance of the commercial
banking sector of Bangladesh. Some comprehensive research report by Ahmed (2007 a); Alam et
al (2007); Bies (2002); Podder and Mamun (2004); Raquib (1999); Islam and Ahmed et al.,
(2006) have revealed the key contributory factors that have been impacting the credit
performances of the commercial banking sector of Bangladesh. These are: (a) inefficiency of
bank management (b) inadequate practice of corporate governance (c) banking regulations
inefficiency (d) inability to implement transparent banking regulation (e) high governmental and
political influence (f) poor practices of credit management system such as: poor loan risk
assessment, poor collateral management, lack of use of management information systems and so
on. Under this state, improvement of such contributory factors has become crucial for the
survival of the banking sector of Bangladesh.
opacity and strong regulated environment of banks are the critical factors of having distinctive
corporate governance systems. Adams and Mehran (2003) argued, due to information
asymmetries the loan quality information may not always readily apparent and consequently loan
may be sanctioned to such clients who actually had a bad credit history. Moreover, banking
organizations with low quality information on equity returns are more likely to experience
declining stock price (Haggard and Howe, 2007). Morgan (2002) has experienced acute barriers
in acquiring information regarding bank’s on-going activities and which in turn disrupt the
traditional corporate governance system.
3: METHODOLOGY
This study is more likely qualitative in nature and majorly relied on secondary data. With the
combination of non-probability sampling technique (firstly, banks with the required information
were initially selected) and stratified random technique (then selected based on their sector-wise
classification) sampling has been done. Finally, total of 29 commercial banks (i.e. 4 SCBs and 25
PCBs) were used as sample for the period of 2011. The research question of this study is
completely related to commercial bank’s credit performance and credit operation, and hence,
sampling frame would be the complete list of all commercial banks other than, foreign
commercial banks and Islamic banks. Due to unconventional banking practices, commercial
banks that follow ‘Islamic Banking System’ were excluded from sampling. And also, due to
foreign ownership issue, foreign commercial banks have been omitted. Relevant data from
several secondary sources such as: statistics of Bangladesh’s scheduled commercial bank,
economic trends, annual reports, quarterly reports, articles, prior research paper were analyzed to
answer the research questions. Data on credit operations and credit performances of both public
and private commercial banks has been compared from different point of view. Several measures
such as: credit operation and credit management approaches have been undertaken for the
purpose of critical comparison as well as to determine the level of impact of the key contributory
factors on both the SCBs and PCBs.
4: FINDINGS
4.1.1: CORPORATE GOVERNANCE PRACTICE: BOARD STRUCTURE
In corporate governance system board are being held responsible for making strategic decision
on behalf of all owners. Both the SCBs and PCBs in Bangladesh contain averagely 10 board
members and major of who are sponsor shareholders. SCBs are much better off by holding
maximum number of ‘non-executive’ independent directors as compared to PCB’s two
independent directors (averagely). The remaining part of PCB’s board of director is sponsor
shareholder. 40 per cent of PCB’s board members were observed to remain with the same post
for more than 5 years (for single term) whereas; the relevant law restricted this tenure in 6 years
(i.e. 3 years tenure 2 times). Moreover, less participation of independent directors has increased
the lack of corporate accountability and transparency. The SCBs on the contrary, have been
suffering from excessive political interferences in the appointment of so-called independent
directors and resulted in producing “loyal doll” of ruling political parties who, naturally serve the
their interests in order to grip their own position (Byron, 2013 February; Muhiuddin. et al., 2008;
Rahman and Rahman, 2005)
shareholding of more than 10 percent by the members of one family. Each and every strategic
decision of PCBs e.g. hiring or firing of CEO, loan approval, salary structure determination and
so on are highly influenced by sponsor shareholding directors. On the other hand, SCBs in
Bangladesh are politically motivated. Most of the loan extension decisions are directly guided by
politicians. 90 percent of SCB’s default loans were guided politically. Around BDT 2100 billion
default loan of SCBs in 2012 as compared to BDT 951 billion in 2011 states how badly the
political influence has deteriorated the NPL problem of SCBs (Byron, 2013 February; Uddin and
Choudhury, 2008; Muhiuddin et al., 2008; Reaz and Arun, 2006).
4.1.3: MANAGEMENT SOUNDNESS
The management of both SCBs and PCBs are highly controlled by the bank’s owners. Accept
foreign banks, 82 percent CEOs of both kinds are held responsible to their respective boards. The
job contracts of CEOs of PCBs are directly linked to their performances whereas, CEOs of SCBs
are appointed by the office of ministry of finance and therefore, instead of performance, loyalty
is more crucial there. The executives of PCBs are more qualified than those of SCBs. The
management compensation for top-level executives in PCBs is also more competitive i.e. about
10 times higher than the SCBs. Islam and Ahmed (2007 b) argued that the customer service
quality of SCBs is standing below the standards maintained by PCBs. High influences from trade
union along with staggering employee’s corruption, political involvement, less employee
motivation and incompetency has deteriorated the loan extension decisions and recovery
performances of SCBs (Transparency International, Bangladesh, 2000).
the operations of SCBs are highly motivated politically which has pretty less commercial focus
in it. Byron (2013 February) mentions due to legal inadequacy, actions are rarely taken against
any wrongdoer of SCBs.
Figure: 1.1 CAR maintained by SCBs and PCBs (Source: Bangladesh Bank, 2011)
University of Science and Technology Annual (USTA)
According to the Fig: 1.1, in the financial year of 2005-2010, SCBs (4 nationalised commercial
banks) could not maintain minimum level CAR. Due to shortage of owner’s equity, provisions,
and high operational expenditure, they could manage to maintain 5.57% CAR against 10%
prescribed CAR. Where, PCBs maintained averagely 10.52% CAR in the same fiscal year.
Figure 1.2: Non-Performing Loans of SCBs and PCBs. (Sources: Bangladesh Bank, 2011)
Figure: 1.3: Comparative position of provision adequacy (Source: Bangladesh Bank, 2011)
Figure: 1.4: Term loans and the stand of SCBs & PCBs. (Source: Bangladesh Bank, 2010)
PCBs from the loan recovery point of view are in better position though, associated with
increasing amount of outstanding loans. A lesser amount of loan overdue (i.e. averagely below
10 percent of loan outstanding), in comparison with SCBs (i.e. average more than 25 percent),
University of Science and Technology Annual (USTA)
indicates a much better credit and collateral administration of PCBs. The comparative
discussions on credit management factors indicates, SCBs in Bangladesh has neither been
managed efficiently, nor been able to utilize the amended regulations and regeneration programs
as did PCBs. Chowdhury (2002 b) argues, inadequate central bank’s supervision on bank’s loan
administration in the earlier time, is responsible for the contemporary difficult situation of the
banking sector of Bangladesh.
The Insolvency Act of Bangladesh is not up to the mark. Special civil court name
“ArthaRinAdalat” (Money Loan Court) was founded in the year of 1990, with inadequate
jurisdiction. Rahman (2007) mentioned that, loan recoveries were interrupted due to several legal
barriers such as: awkward and time consuming procedures, leisurely disposal of cases, shortfall
of special cases, extreme number of stay orders, difficulties of possessing defaulter’s assets,
limited judges, and so on. Furthermore, Monsur (2006) has found several limitation of the
Insolvency Act, firstly: the court cannot try any civil and criminal cases [Chapter: 3, section
5(8)]; secondly: the Act lowered the jurisdiction of court maximum BDT 500000 (Five Lac) for
the claim extended by SCBs without any explanation [Section 5(5)]. The court refrain any kind
of claim proceedings against government. In this Act, Chapter 5, Section 21/22 has been
dedicated for resolving dispute among loan defaulters and bankers. But, due to some
controversial clauses of the Insolvency Act, such as: loan rescheduling and installment based
payment permits prior to any law suits (section 38/46); unapproved time (section 49), motivates
both the banks and loan defaulters to lingering judicial actions, which is often resulted in a
compromising settlement by illegitimate loan rescheduling. Transparency International,
Bangladesh (2007) has also mentioned that, a defaulter can get his or her default loans
University of Science and Technology Annual (USTA)
rescheduled if, 10 percent of that classified loan can be paid. Moreover, the outdated and
inefficient company winding up procedures along with high bureaucracy has limited the role of
liquidators and thus, prolongs the whole process. Such long haul liquidating process
accompanied by less return from defaulter’s assets practically fails to compensate the loan
default loss (Batra, 2006).
Under this situation, refinement of such infected banking systems is obvious for stabilizing
country’s financial sector.
Ahmed (2007 b); Bhattacharya and Chowdhury (2003); Reaz and Arun (2006) emphasized on
implementing an integrated corporate governance culture especially for state-owned commercial
banks. They have suggested structuring unbiased regulatory body that will monitor irregularities
as well as variations among corporate governance standards and its real world practice.
Privatization has been emerged as panacea, nevertheless, without effective prudential legislative
framework the whole effort may collapse in vain. Successful privatization may eliminate such
problems as: lack of banking supervisions; lack of regulations and enforcement; capital
deficiency and managerial incapability, which are responsible for current banking crisis.
Furthermore, increasing only the managerial competency without minimizing political
interventions is not enough. Political commitment, appropriate legal environment along with
bank’s managerial competency, together can improve the whole financial sector. Andrews
(2005) has suggested some guiding principles of privatization. Firstly, that process must be
administered by an independent non-political body. Secondly, that initiation must choose
investors in terms of commercial values not in terms of socio-political values. Finally, the
privatization process must need to be concentrated more on reducing governmental shares
coupled with a resolution of minimizing the bad debt problems of SCBs.
Bangladesh Bank itself, is needed to be transformed into a true autonomous organization, so that,
it can run its regulatory wings without unnecessary governmental interventions. Credit
Information Bureau (CIB) is required to be equipped with modern infrastructure and expertise to
provide impartial and true credit history of all kinds of credit seekers. The law and enforcement
authority of ‘Money Loan Court’ needed to be enhanced for the better protection of bank’s
interest from the possible default loan loss. SCBs of Bangladesh do need to give more
concentration on its credit management system and adequate precautionary measures must be
taken while disbursing loans. An efficient supervision and monitoring system can be adopted to
observe client’s loan utilization activities. In this regard, strengthening law and enforcement is
obvious for reducing the level of non-performing loans. Financial or non-financial penalty for
loan defaulters and reward for timely loan payers can be arranged. Loan rescheduling practice
must be conformed to the regulation and be freed from any sort of third party’s influence. Islam
and Ahmed (2007 b) and Alam et al, (2007) mentioned that the SCBs in Bangladesh are
surprisingly lagged behind in such areas as: modern information technology and customer
service which, subsequently affect the overall banking operations and credit performances.
Therefore, these two areas cannot be neglected while implementing an efficient credit
management system
REFERENCES
Adams, R. and Mehran.H. (2003). “Is Corporate Governance Different for Bank Holding
Company?” [Online] FRBNY Economic Policy Review, Vol. 9(1), pp.123-142. Available at:
University of Science and Technology Annual (USTA)
Morgan, D. (2002). “Rating Banks: Risk and Uncertainty in an Opaque Industry.” [Online]
American Economic Review, Vol. 92, pp. 874-88. Available at: http://www.jstor.org/
(Accessed December 7, 2012).
Munshi, J. (2000). “Corruption in the Banking Industry in Bangladesh” [Online], Transparency
international. Available at: http://www.ti-bangladesh.org/ (Accessed December 4, 2012)
Muhiuddin, K. M. G. et al (2008). “Corporate Governance Compliance: A study of the listed
companies based on CSE-30 Index.”[Online].The Cost and Management. Issue: September-
October pp.13-20. Available at: http://www.icmab.org.bd/ (Accessed December 9, 2012)
Paul, S.Y. (2007). “Organizing the credit management function.” Credit Management, Issue:
July 1, pp.36-38. Institute of Credit Management (ICM)
Podder, J. and Mamun, A.A. (2004).“Loan loss provisioning system in Bangladesh banking, a
critical analysis”. Managerial Auditing Journal, Vol. 19 (6), pp. 729-740. MCB University
Press Limited.
Rao, N. and Tiwari, S. (2008). “A study of factors affecting efficiency of public sector banks”.
Journal of Services Research. Vol. 8 (2) Issue: October, pp. 73-89.
Rahman, F. (2007).Artha Rin Adalat Ain 2003: A Review. Newsletter: Banking, Finance,
Corporate, Commercial, Property & Constitutional Legal Issues [Online]. Dhaka, Bangladesh
Available at: www.rahmansc.com/Doc/Volume_1_2007.doc (Accessed November 29, 2012).
Rahman, L. and Rahman, R. (2005).“Baseline Study on Corporate Governance Practices in
Bangladesh.”[Online]. Bangladesh Enterprise Institute, Dhaka. Available at: http://www.bei-
bd.org (Accessed December 7, 2012).
Raquib, A. (1999). “Financial Sector Reform in Bangladesh: An Evaluation”. Bank Parikrama.
Vol. XXXIV, pp.3-4.
Reaz, M. and Arun, T. (2006). “Corporate Governance in Developing Economies: Perspective
from the Banking Sector in Bangladesh.” Journal of Banking Regulation.Vol.7. no. 1(2) pp.
94-105.Journal of Banking Regulation. Palgrave Macmillan Ltd.
Rehman, S. (2000).“Restoring justice to banking in Bangladesh”, Bank Parikrama, Vol. XXV
No. 2/3, June and September.
Sarker, R. M. and Hossain, S. (1997). “Recovery of Bank Loans in Bangladesh: A study on
Problem side Analysis of Sonali Bank Limited”. Journal of Business Studies, Dhaka
University. Vol. 18(2), pp 121 – 146.
Siddiqui, J. and Podder, J. (2002).“Effectiveness of Bank Audit in Bangladesh.”Managerial
Auditing Journal. Vol. 17(8), pp. 502-510.
Stevenson, P. (2005). “Credit management policy.” Credit Management: Credit Policy, Issue:
January 1, pp. 8-18. Institute of Credit Management (ICM).
University of Science and Technology Annual (USTA)
Transparency International Bangladesh (TIB) (2007). The State of the Governance in the Power
Sector of Bangladesh: Problems and the Way Out. Dhaka: TIB.
Transparency International Bangladesh (TIB) (2000) .Corruption in public service departments.
Dhaka: TIB.
Uddin, S. and Choudhury, J.A. (2008). “Rationality, traditionalism and the state of corporate
governance mechanisms: illustrations from a less developed country.” Working Paper No.
08/08.University of Essex.