Bangladesh Banking Sector Faces Liquidity Strain Amidst Rising Loan Defaults

Bangladesh’s banking sector is navigating a period of heightened liquidity pressure, as a surge in non-performing loans (NPLs) and a slowdown in deposit growth strain the financial stability of several major lenders. According to the latest data from the Bangladesh Bank, the central bank, the ratio of defaulted loans to total outstanding credit has climbed to 9.6% as of June 2024, up from 8.8% in December 2023, marking the highest level in over a decade.

Industry analysts attribute this deterioration to a combination of factors, including the lingering effects of the COVID-19 pandemic, rising inflation, and a slowdown in export demand from key markets such as Europe and the United States. Small and medium-sized enterprises, which account for a significant portion of bank lending, have been particularly hard hit, with many struggling to service debts amid higher input costs and reduced consumer spending.

“The banking sector is facing a classic squeeze: loan quality is worsening, while deposit growth is not keeping pace with credit expansion,” said Dr. Shahiduzzaman, a former deputy governor of Bangladesh Bank. “This is forcing banks to borrow from the central bank’s standing lending facility at higher rates, which further compresses their margins.”

In response, the Bangladesh Bank has taken steps to inject liquidity into the system. In early October, it reduced the cash reserve ratio (CRR) by 50 basis points to 3.5%, freeing up an estimated Tk 150 billion (approximately $1.4 billion) for lending. The central bank also extended the tenure of its special refinancing scheme for banks facing short-term shortages, allowing them to borrow at a concessional rate of 5.5%.

However, critics argue that these measures are insufficient. “The CRR cut is a short-term fix, but it does not address the root cause of the problem, which is poor governance and weak risk management in many banks,” said M. A. Mannan, a former finance secretary. He pointed to a recent central bank report that identified 11 state-owned and private banks as “weak” or “fragile,” accounting for over 40% of the sector’s total assets.

International observers have also raised concerns. The International Monetary Fund, in its latest Article IV consultation report, warned that Bangladesh’s banking sector vulnerabilities could pose a risk to macroeconomic stability. It recommended stricter provisioning norms, improved supervision, and faster resolution of distressed assets. The World Bank echoed these sentiments in a separate assessment, urging the government to expedite the reform of state-owned commercial banks, which collectively hold the highest NPL ratios.

On the international front, the challenges in Bangladesh’s banking sector mirror broader trends in emerging markets. A recent report by the Asian Development Bank noted that banking sectors across South Asia are under strain due to rising global interest rates and geopolitical uncertainties. However, Bangladesh’s situation is compounded by its heavy reliance on the readymade garment industry, which accounts for over 80% of exports. A slowdown in global demand for apparel has led to delayed payments and increased defaults among textile manufacturers.

Despite the headwinds, some banks are performing relatively well. Private sector lenders such as BRAC Bank and Eastern Bank have reported higher profits in the first half of 2024, driven by strong growth in retail and digital banking services. These institutions have invested heavily in technology and have diversified their loan portfolios to include more consumer and SME lending.

Looking ahead, industry experts expect the liquidity crunch to persist into early 2025, unless the government takes more decisive action. Proposals include recapitalizing state-owned banks, strengthening the asset management company to purchase bad loans, and tightening regulations on new loan disbursements. The Bangladesh Bank has also signaled that it may introduce a tiered capital adequacy requirement, forcing riskier banks to hold more capital.

For now, depositors and investors are watching closely. The stock market has already felt the impact, with shares of several banks falling sharply in recent weeks. “Confidence is key,” said Dr. Shahiduzzaman. “If the central bank and the government can restore trust in the system, the sector can weather this storm. If not, we could see a more serious crisis.”