The International Monetary Fund (IMF) has suggested the regulatory authorities adopt a comprehensive timely action plan to help maintain confidence in the banking system.
It has recommended that the Bangladesh Bank (BB) tighten grip on criteria for rescheduling or restructuring of loans and avoid their repeated uses.
The Washington-based lender observed that strict and prompt remedial actions should replace regulatory forbearance for banks as part of a broader plan.
"Clear criteria should also help prevent the BB's involvement when banks grant rescheduling or restructuring for specific cases," it said.
The global monetary watchdog released on Wednesday its latest Staff Report on Article IV Consultation Mission of Bangladesh.
When asked, Association of Bankers, Bangladesh (ABB) chairman Syed Mahbubur Rahman said regulators normally provide forbearance considering the demand of time but it should be allowed only for genuine cases.
"Repeated uses are always a misuse," explained Mr Rahman, also managing director and chief executive officer of Dhaka Bank Limited.
IMF made the recommendations against the backdrop of a rising trend in stressed assets in the banking sector.
Stressed assets are defined as the sum of gross non-performing loans (NPLs) plus restructured and rescheduled advances.
The stressed asset ratio climbed to 20.5 per cent in 2018 from 19 per cent in 2017 for the growing volume of non-performing assets and rescheduled advances, revealed BB's latest financial stability report.
The IMF report also cited a growing trend of loan rescheduling and restructuring, including those granted by BB on an individual basis.
"This reflects mainly the very high stressed assets in state-owned commercial banks (SoCBs), though the stressed asset ratio has also increased in private commercial banks in recent years," it explained.
The NPL ratio has increased from 9.3 per cent at the end of 2017 to 10.3 per cent at the end of 2018.
Most NPLs are in SoCBs, with the end-2018 ratio standing at 30 per cent.
"The published NPL ratio likely underestimates potential problems in the banking sector," IMF noted.
To achieve a sizeable NPL reduction, it recommended more fundamental reforms, including better credit risk management and strengthened regulatory enforcement.
The multilateral lender, however, said the high level of stressed assets limits banks' ability to engage in new lending and also restricts access to credit.
The worsening asset quality reflects a combination of factors like poor diligence and compliance with risk management practices, according to the report.
It also advised the authorities concerned to take prompt actions to address the banking sector's financial stability as well as associated fiscal risks.
While banks' credit to the private sector remains at around 40 per cent of the gross domestic product (GDP), total stressed advances are almost 9.0 per cent of GDP.
SoCBs shortfall in required capital is at 1.0 per cent of GDP, based on the authorities' estimates.
IMF also said the financial situation in the sector continues to deteriorate despite strong economic growth of Bangladesh.
Legal systems should be strengthened to help banks recover NPLs, particularly those by wilful defaulters. IMF said further strengthening capacity and efficiency of the court could expedite the legal process.
"Banks' corporate governance needs to be strengthened. Serious graft cases point to insufficient internal control and risk management. Loan concentration limits should be observed."
About public commercial banks, IMF said the role of SoCBs needs to be reassessed.
"A limited number of SoCBs with clear public mandates could receive transparent budget support. Others should be converted to banks operating on commercial principles or closed," it recommended.
IMF also said the government should address key bottlenecks like insufficient infrastructure and governance weaknesses to promote investment.
"A strengthened macroeconomic policy framework and further diversification of economy would enhance resilience, including the ability to adjust to climate change, an important risk for future growth," it noted.
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