Bangladesh Bank has recently extended the deadline up to December 31, 2018 for bringing down Advance Deposit Ratio (ADR) of commercial banks below the benchmark set earlier. Previously this timeframe was set for June 30, 2018. Earlier Bangladesh Bank (BB) reduced maximum benchmark of ADR from 85 to 83.5 per cent for all conventional commercial banks. Allowing further time for reducing ADR indicates that banks have exceeded this benchmark ratio by disbursing more loans and advances than what they are supposed to do. However, a brief report published on this issue has not made it clear that whether higher AD (Advance Deposit) ratio has been caused following the central bank's lowering the benchmark ratio or banks have exceeded this ratio by disbursing excessive loans and advances.
If the present situation is the impact of former action, then Bangladesh Bank should not have taken this decision fully knowing that brining down this ratio below the threshold level is not an easy task at all, particularly in our country where banks' alternative source of finance is almost nonexistent. Bangladesh Bank should have gradually compelled the banks to bring down the ratio and then fix the maximum ratio with cautionary warning of taking severe punitive action against the violators, so that this ratio never exceeds.
Now, Bangladesh Bank's decision has left the commercial banks in the most difficult situation to comply with and on the other hand, providing exemption or extending deadline time and again by the regulator is always viewed with weak regulator approach, which is not a good sign for the country's financial industry.
Further, the report did not even specify whether AD ratio of some selective banks is over the benchmark ratio or industry average, i.e. whether cumulative impact of all banks' ADR has exceeded this maximum threshold. In the former situation, Bangladesh Bank should not have provided general extension of deadline for the whole industry; instead they should have selectively approached to those particular banks which are now running with their ADR above maximum threshold level. On the other hand, the later situation is more alarming as the scope of reducing this ratio will substantially be limited and banking industry as a whole will now be exposed to liquidity risk.
CAUSES OF HIGHER ADR: Historically, banks and financial institutions are known as dealers of other people's money. They mobilise deposits from the surplus units who are mainly known as depositors and channel this fund to the deficit units who are categorically known as borrowers. Fund mobilised by the banks is called deposit while money lent to the borrowers is known as loans and advance. Banks always maintain a comfortable buffer between the amount of deposit mobilised and the quantum of loans disbursed by them. This buffer is defined as Advance Deposit Ratio in financial terminology.
Because of the nature of banks' business, this ratio can never be static, as every transaction in bank's deposit or loan results in the change of this ratio. Banks do not have control over the amount of deposit as the depositors may withdraw their money at any time and banks are legally bound to allow depositors withdrawal request. Even bank cannot stop encashment of FDR (Fixed Deposit Receipt) although this is known as term deposit which the depositors should not withdraw prior to maturity. At best, banks may not pay interest for any broken period but cannot help paying off the money deposited as FDR.
So, any major withdrawal by the depositors will cause to raise ADR provided proportionate amount of loan is not paid off. At the same time, deposit is the function of interest rate and when this rate is reduced, there is a possibility of further raising ADR and even may exceed the maximum threshold level. This ratio may also be exceeded if the banks committed loans, unused commitment, uncommitted loans, maturity schedule of term loans, disbursement schedule, contingent loans are not taken into consideration while approving new loans. Loans approved by a bank is not always disbursed instantly because the borrower withdraws as per their requirement, so the loan amount approved is known as committed limit while the amount of loan not disbursed but to be disbursed at any time is known as unused amount.
Similarly, banks in many cases approve commitment against which disbursement is not made unless some event associated with underlying transaction takes place. Term loan is followed by predetermined repayment schedule based on which borrowers pay off the loans. At the same time, there are some types of commitments which follow disbursement schedule based on which loans are disbursed over a period of time -- for example project loan. Repayment schedule reduces the loan portfolio which eventually improves Advance Deposit Ratio while the adverse impact is experienced due to disbursement schedule. Similarly, banks always extend many non-funded credit facilities which commonly include bank guarantee, SBLC (Standby LC), commercial letter of credit. These forms of credit facilities do not involve fund movement but may be drawn any time requiring fund disbursement. Therefore, a certain percentage of banks' committed non-funded credit facilities should always be considered as funded credit facility. While assessing banks' maximum cap on loans and advances, all factors, which include committed limit, unused limit, uncommitted limit, repayment schedule, disbursement schedule and percentage of bank's total non-funded credit facilities, must be taken into consideration in order to properly determine the ratio between bank's advance and deposit. If any deviation is allowed, there is the likelihood of exceeding the benchmark AD ratio.
In my banking career, I have experienced that new loans and advances are approved as a part of achieving budgetary target and at best, total outstanding amount of loans and advances are taken into consideration. So, predetermined ADR is hardly followed in our country and even sometimes excess disbursement of loan causes liquidity crisis resulting in skyrocketing interbank borrowing (call money) rate. During the period 2004-2005, this crisis took an acute shape as interbank borrowing rate soared to 60/70 per cent.
Moreover debt servicing practice and loan operation procedures being followed by our bank are not conducive at all to maintain standard ratio between advance and deposit. There is no practice of revolving term loan under which loans on various terms -- for week, month, quarter etc., as per requirement of borrower -- will be drawn and thus will be paid off along with interest accrued thereon on maturity. This draw and repayment of loans will continue unabated until the termination or expiry date of the facility itself. In our country, loans disbursed is hardly paid off, rather continued for indefinite period in the name of renewal and restructuring of the credit facility. Even, the borrower hardly makes payment off interest accrued on loans. That means interest is not paid in cash, instead accounted for, i.e., accumulated with the loan balance.
So, debt servicing in true sense is not followed in our country and this definitely impacts ADR of commercial banks. Without bringing about qualitative change in loan operation and replacing widespread use of so-called overdraft facility, this situation cannot be improved. The central bank, commercial banks, think tanks and policy makers should carefully look into this area and thus develop a standard practice for loan operation of commercial banks.
IMPACT OF HIGHER ADR: Standard and adequate ratio between advance and deposit must be maintained in a bank's business because inadequate ratio causes severe problem. Bank's liquidity risk may mount if the ratio rises too high because this may restrict its ability to return depositors' money. Once a bank's failure to return depositors' money is reported, a contagious effect will likely sweep over the whole industry as depositors, feeling unsecured, may go for massive withdrawal of their deposits. In many countries this kind of situation may invite bankruptcy to the banks.
The writer is a banker based in Toronto, Canada.
