This section provides an overview of the current structure of the banking system in Bangladesh. The formal financial sector in Bangladesh includes: (a) Bangladesh Bank as the central bank: (b) 22 commercial banks, including four nationalized commercial banks, two denationalized private banks, ten domestic private banks and six foreign private banks: (c) four Government-owned specialized banks, two of  which have targeted the agricultural sector and the and two others serve industry: (d) one Government-owned investment company: (e) four non-bank financial institutions:(f) two leasing companies:(g) two large Government-owned insurance companies :(g) two large government-owned insurance companies (life and general) and several private insurance companies, including one foreign owned: and (h) the Dhaka Stock Exchange(DSE). Table 1 provides an overview of the institutions in the Bangladesh Financial Sector.

The roots of Bangladesh Bank (BB) date back to reserve Bank of India out of which the State Bank of Pakistan was created in 1948. Bangladesh Bank took over central banking functions from the State Bank of Pakistan at the end of 1971. The Bangladesh Banking Order of 1972 specifies BB’s central banking responsibilities and gives it substantial powers to formulate and implement monetary and supervisory polices and to advise the Government on economic policy. The Banking Companies Act (1991) and Financial Institutions Act(1993) specify a wide range of prudential requirements and extend BB’s powers to issuing directions to banks and financial institutions.

The financial health of Bangladesh Bank is good without any open or hidden losses. Its lending to the Government is moderate. BB operates the country’s payments system reasonably well even with a poor transport and communication infrastructure. However, Bangladesh Bank supervision is rather weak because of an inadequate number of bank auditors. There is a strong need to continue to strengthen BB as it would otherwise not be capable of supervising an expanding an increasingly liberalized financial system.

Table 2 presents the volume of deposits and advances in the banking system over the 1981-92 period. Deposits are Taka 2,600 core and advance Taka 2,250 core at the end of 1992. During the period of the financial sector reforms deposits have grown at rates of 10-15 percent per annum while advances rose first and then dropped sharply in 1992. The drop was probably caused by loan provisioning and agricultural credit write-off rather than a decline in the volume of advances. Table 3 provides the ratio of broad money to GDP. This ratio is a measure of financial deepening. The higher the ratio, the greater the level of financial deepening in the economy. This table indicates that there has been no significant increase in the financial deepening of the economy in the three year period before the reform. The ration was stable at 27percent for the three years and then resumed its growth to 29 percent.

Commercial banks dominate the financial system of Bangladesh. Table 4 presents a deposits and advances by type of a bank over the 1986-1993 period. Four nationalized commercial banks dominate the banking system with 63 percent of bank deposits and 53 percent of advances in deposits from 69 percent to 63 percent and in advances from 56 percent to 53 percent, percent. They continue, however, to exert oligopolistic market power over the banking system. NCBs have helped to further the Government’s socioeconomic objectives by expanding their rural branch network and lending to agriculture, lending to small scale and cottage industries and funding state-owned enterprises.

Domestic private banks, which include two denationalized banks, increased their market shares between 1986 and 1993, in deposits from 20 percent to 27 percent and in advances from 14percent to 25 percent. These banks expanded their network by 33 branches, comprising 85 percent of the 39 new branches created during fiscal year 19920 The domestic private bank’s growth is more impressive, if data for the two denationalized banks are excluded. The denationalized banks share many of the same problems as NCB Domestic private banks offer higher interest rates to attract deposits and charge higher rates on loans. Their service is considered better than NCBs and they have expanded into fee-based and international services. These banks compete for a limited number of creditworthy borrows, but not with NCBs for priority or public sector lending.

As BB’s supervision improves, owever, problems in the private bans are also emerging, including insider lending. They also face problems of capital adequacy. Foreign banks lost market share in deposits from 6 percent in 1986 to 5 percent in 1993, partly because of the failure of Bank of Credit, Commerce International (BCCI), partly because the offer lower deposit rates, These banks cater to multinationals, international transactions and high net-worth individuals. Table 5 presents a breakdown of public and private sector loans. The Government and the public sector accounted for 23 percent, and  the private sector 77 percent of deposits in FY91, about the same distribution as in the previous year. The Government and public sector increased their share of bank credit from 31 percent in FY91 to 39 percent in FY93, reducing the rivet sector’s share commensurately. If the Government bonds issued to NCBs for recapitalization are excluded, over the medium term the share of public credit has remained more or less unchanged.

Table 6 gives the number of branches for the different types of banks. This table indicates that there are a number of large branch banks followed by the foreign and private banks, which have much more3, limited branch networks.

The NCBs have branched networks average 900 branches: an extremely large number. The networks have emerged from years of management concentration on deposit mobilization and providing banking services to rural areas. The NCB’s drive to expand their deposits arises from the continual need to provide fresh funds in an environment of poor loan recovery. As deposits are clearly associated with branch numbers, while advances are industry and location specific, the need to expand deposits leads directly to expanding branch networks. Urban branches are better sources of deposits than rural branches so the primary objective is to increase urban banshees. However, central bank policy required that the rural branch network be expanded at the same time, to provide banking services in such areas. Taken together these two factors led the NCBs to increase their branch network rapidly.

The two denationalized banks have much smaller branch networks than the NCBs: Their rural networks have been cut back since denationalization. Of the specialized banks two have large network and one a very small network. The two agricultural credit banks have more than 1,000 branches. Domestic private banks average 50 branches and foreign banks only 4.

Table 7 provides a breakdown of rural d urban branches of all banks. This structure of the banking system is very clear. The Government banks have very large urban branch networks (300/bank): the private banks, excluding the denationalized have much smaller  networks (41/bank) and the denationalized banks are in between with 130/bank. Apart from the very large rural networks of the NCBs, their urban networks are 7-8 times larger than that of the other banks.

A large branch network is important for collection of deposits and to provide the public with general banking services. Companies and  people want to maintain deposits at a convenient branch so the number and location of branches are an essential element of any strategy  to mobilize deposits. The massive branch networks reflect the explicit NCB strategy of deposit mobilization. The growth of the branch network has been an important element in the growth of deposits over the past 15 years.

The large branch network is very difficult to monitor and control. NCBs have shown to date, limited capacity to control their branch operations. The poor control of the branches is reflected in the high costs to the banks of the inter branch reconciliation balances and the high levels of bad debt. The NCBs have not effectively decentralized control of the branches so that the span of control required of the Head Office far exceeds anything that effective management can handle.

All nationalized and denationalized banks in Bangladesh are undercapitalized even under the current standard, which is somewhat lower than the minimum recommended by the 1992 Basle Committee. The Government recapitalized the NCBs to the tune of Taka 17.3 billion in 1992 and Taka 14.6 billion in November 1993. The recent capitalization has been necessary because of the laxity in recognizing losses and continued bad lending. In addition, previous recapitalization did not cover bad jute loans. While estimates of bad debts are not definitive because of weak prudential standards, they are likely to be substantial.

The high default rate among NCB borrowers has occurred because of poor management, lack of little incentive to make good loans and Government direction and intervention. NCBs were required to make high-risk loans to priority sectors, new entrepreneurs, public corporations, sick industries and borrowers with political influence. In addition, these NCBs were obliged to endure loan forgiveness programs by the Government. Their own lending practices were not based on sound lending principles. For example, these NCBs have used imprudently high equity ratios as  basis for lending. They have also been lulled into a false sense of security because their lending has been collateralized and bad loans were masked by inadequate accounting  practices.

It is nearly impossible to foreclose on collateral and liquidate it. The recent legal reforms undertaken as part of the financial sector reforms have enabled the banks to obtain decrees in their favor from the Financial Loan Courts in their cases against defaulters. However, very little collateral has actually bee liquidated because of weak legal enforcement mechanisms. These problems will have to be strengthened by substantial improvements in enforcement.

The two denationalized private commercial banks inherited substantial bad loans from the nationalized period. At the time of denationalization, the quality of their loan portfolio was not fully disclosed to there former owes. Equipped with a bad loan portfolio and poor lending practices, these banks have conducted their business as if they were still CBS. Not surprisingly, they have not come up to normal commercial banking standards under the new and tighter banking control and supervision. Their net worth is likely to be seriously eroded, especially since they have not had the recapitalization support provided to NCBs.