The purpose of this research is to analyze the banking system in Bangladesh, and to suggest policies to encourage privatization of commercial banks in Bangladesh. This research specifically examines the financial statements (balance sheet and income statements) of both nationalized commercial banks (NCBs) and private banks, and statistically analyzes them to understand their relative performance over the past two decades. There are various lessons to be learned from this.

The development of financial markets will increase the efficiency of the flow of funds between savings and investment. Increased efficiency will take place through a variety of mechanisms: the cost of intermediation will decrease because of increased competition to attract users and providers of funds; the cost of raising funds will decrease as the inflation rate declines: and funds will increasingly be allocated to users with better investment projects. The establishment of a market driven private banking system is linked to achieving higher employment, increased productivity, more efficient use of resources and more rapid economic growth in Bangladesh.

Banks, in general, perform three basic functions valued by the overall economy. One of these functions is the centralization of credit evaluation and monitoring, which produces information that cannot be easily made public by the borrower. This centralization exploits cost economies and, together with a diversified loan portfolio, lowers the raise of credit. Second, banks offer transformation services that convert claims issued by borrowers into instruments that investors are willing to hold. These claims may be transformed with respect to their maturity, liquidity and credit risk. This special role of banks derives from the social welfare enhancements that can be realized when banks coordinate the funding of these illiquid assets with liquid liabilities.  Third, banks provide access to payments system and to a clearing house for transactions. Public policies to attain safe and sound banking have traditionally been focused on methods to assure the continuous and efficient functioning of their transactions and payments mechanism. However, whether these services are rendered optimally by nationalized or private banks inconsistent and open question, and this research will shed light on the relative merits of these two types of banking system for Bangladesh.

The health and efficiency of the financial sector are crucial to economics growth. It is the system by which a country’s most profitable and efficient projects are systematically and continuously funded, and thus it is the mechanism, which ensures that resources are directed to the most productive sources of future growth. The financial system not only transfers funds from savers to investors: it must be able to select projects which will yield the highest returns, accumulate sufficient quantities of capital to fund the range of investment projects across economic activities, account for price risks across assets, monitor performance, and enforce contracts.

This financial sector requires a highly skilled manpower and quality information to undertake this vast range of tasks. The most common role of government in successful financial systems has been to ensure that financial institutions serve these vital functions as efficiently as possible. That role has taken the form of regulation to monitor and enhance bank solvency and to limit financial sector instability. The efficiency of national investment depends on the complementary roles of both the private and public sectors.

The NCBs have expanded credit to priority sectors in response to government directives without due regard to quality, often at interest rates below the bank’s cost of funds. This had led to inefficient resource allocation and widespread bad loan. It has become increasingly difficult for the banking system to play its essential role of supporting the country’s economic development and adjustment goals. The esteem of these problems reduces the level of investment, the productivity of capital and the volume of savings. This results in reduced economic growth and employment opportunities.

Bangladesh’s continuous stagnation in investment and economic growth is related to the situation in its financial sector. The financial sector has the potential to contribute to economic and industrial growth by enhancing resource mobilization and improving resource allocation. By enhancing resource mobilization and improving resource allocation. At present, Bangladesh has a small undeveloped financial sector. It contributed 2.1 percent to GDP in 1998, declining to 1.8 percent by 1992; the sector is growing slower than GDP. In terms of the usual measure of financial deepening (M2/GDP0), however, there was a small gain, from 29 percent in FY89 to 33 percent in FY93. While the extent of bad debts in the nationalized commercial banks is now known with accuracy, they are believed to be substantial. If these bad loans are also bad investments, Bangladesh’s capital/output ratio will have been adversely affected, lowering the rate of economic growth. If the annual  impact of bad investments were compounded over the 23 years since independence, the overall effect on economic growth would be substantial. The main challenge for Bangladesh’s financial system for the near future is to improve the quality of inter mediation and resource allocation to contribute to a more rapid rate of economic growth and higher levels of saving and investment.

This paper is divided into eight sections. Following introduction in section I. Section II focuses on the significance of this research paper, a short history of the financial sector reform is provided in section III. Section IV discuses the current structure of the Bangladesh financial sector Section V presents data related to the comparative performance of nationalized and private-sector banks, and statistically analyze them.  Section VI discusses the privatization of nationalized banks, and lessons leaned from them. Section VII examines the merits of chartering new banks to foster privatization in Bangladesh. Conclusions and policy implications are given in section VIII.