While the importance of a private banking system is paramount, the relevant question is what is the best way to develop one. The competitive approach of starting more private banks and supervising these closely to insure that there is compliance with the various regulations governing the banking system seems to be the best way to  expand the private banks. There are three important points that relate to the development of private banking. First, it must be recognized from the outset that more private banks will certainly lead to problem cases. But, these problems can be handled high protecting the depositors to some extent and punishing the owners of the private bank by closing them when their net worth goes below a specified amount. Second, the recent amendments to the Banking Companies Act restricting ownership to 5 percent is certain to cause difficulties with the development of private banks. While the idea of restricting the concentration of economic power is a valid objective, this can be better achieved through the issuance of many bank licenses. Third, the question of more foreign banking may be conceded. If respectable foreign retail and merchant banks are interested in opening up branches, then these banks should be encouraged to start up business. Foreign banks are one of the best ways to encourage private foreign investment.

At present the policy towards new financial institutions in Bangladesh is a case by case approach. There is no strategic policy with respect to the vision of how the financial system would develop. At present Bangladesh has a branch banking system, i.e. a few banks each with a large member of branches in contrast with a unit banking system comprising a large number of banks each with a few branches. The relevant question is what is an optimal banking structure for Bangladesh.

The advantage of a large branch network is based upon the proposition that deposits are collected from many small depositors and concentrated to fund the loans. One should note that by learning to participate in consortium, large loans can be managed by groups of small banks. Small banks. Small banks can also mobilize funds and make these available to large city banks for lending. The connection between concentration of deposits and large loans within a single bank is not necessary.

The management of the banking sector has two primary objectives: (a) to create competition to ensure efficiency and access to banking services:(b) to perform financial intermediation at low total cost. In the context of Bangladesh these objectives have several implications.

Competition is effective only when there is profit maximizing behavior. This means that the financial institution as no objective other than to earn as much profit as possible. Thus, in particular reference to Bangladesh, this profit maximizing behavior means that (a) employment levels should not be maintained except in so for as it contributes directly to bank profits:(b) salaries and other labor compensation should be managed to promote profit maximization (bonuses are incentive based, etc.) 9c) loans are based on the bank’s assessment, not directed to achieve Government development objectives:(d) banks do not have social objectives. If Government works to encourage loans in some sector, the Government should provide the necessary incentive through direct subsidy.

Any essential deviation from the principle of competition  essential deviation from the principle of competition will lead to a loss of efficiency, reduced return to investments financed  by the banks, and reduced payments to savers (depositors). All of these will reduce the rate to growth of the economy. Experience in Bangladesh and elsewhere suggests that if there are market failures the regulations of Government have generally not succeeded in correcting these. Claims to subsidize sectors to offset market failure cannot be and have not been justified analytically. There is no evidence that one can successfully replace competition by regulation. Encouragement of competition should be the objective of government policy, not its destruction. Often it is the very private interests already in the sector that wish to restrict competition through restricting entry.

A second aspect of competition is to create access to the banking system for all persons with good projects. Access is restricted by a number of behaviors: (a government banks where access to funds is regulated by special programs, official objectives, or traditional regulation:(b) banks controlled by an industrial-trading group where lending is largely made available to or through members of the group. Such banks may not provide access t funds for outsiders. Good projects presented by outsiders may by outsiders may be joined by group interests or in some cases taken over.

This suggests that entry of new banks should be straightforward:  otherwise access of borrower will be restricted. It is a myth that only a few private banks promote competition, may are required. It is myth that only a few private banks promote competition, many are required . It is also a myth that Government intervention can select good investments or that Government enterprises work efficiently. One of the conditions of a competitive market is that when profits rise above normal returns entry should be sufficiently easy that new entrants will increase the level of competition. In Asia there has always been concern that banks will fund largely the financial interest of the owners or the business grouping to which the owners below. The nature of business and investment has tended to emphasize family ownership and management:  the separation of management and ownership that characterizes European, Japanese, and North American industry is far less widespread in South Asia and Bangladesh in particular.

Rationed financial access is characteristic of much of Asia. The transition to a world of separation of ownership and management, with owners solely concerned with the return on their investment is probably decades away. One has to expect strong group and family interests to be manifest by private banks. To insure more equality of access to capital, South Asian Governments have in the past nationalized their banks and encouraged the development of directed leading. The alternative approach to achieving increased competition and greater access to capital is to allow easier entry into the financial sector. There is little that can be done to limit group concentration through their ownership of a bank: but it is feasible to have a large number of groups. As competition increases banks become more efficient and the group orientation can survive only  if the group can generate good projects. One under groups are better than ten.

In Bangladesh efforts are made through the Banking control Act 1991 and amendments thereto, To achieve broad-based ownership and to limit the lending to Directors. The concept of broad-based ownership is promoted by limiting the voting power and ownership of any person to 5 percent of the shares. This concept is acutely difficult to make effective and the private banks, with few exceptions, do not really reflect broad-aced ownership. Instead banks come under control of a group. Such control may be majorette ownership or it may be the confidence of other shareholders in management permits such management to operate the bank. Broad-based ownership, which does not permit bank management to operate with an effective strategy, is not likely to prove beneficial. The willingness of person to invest in banks.

Competition in any economic sector requires relative ease of entry and exit. While sole borrowers may have access to foreign financial institutions, most do not so. Hence effective competition can only result from entry when the potential for high profits exists. This point is often overlooked. If there is a perceived potential to earn a surplus then entry should be available even if there are no supernormal profits being earned by existing banks. There may be technologies or ideas that a new entrant can bring to bear on the sector that will lower production costs. New financial institutions may have better ways to collect loans, establish collateral, design more appropriate financial instruments, etc. is wrong to use a concept of capacity of the banking system to limit entry since this reduces the pressure on existing banks to become more efficient.

The exit question is particularly difficult in the financial sector although in Bangladesh this is a pervasive problem in the economy. A financial firm can leave the market in a number of ways: (a) go out of business or be closed down by the bank supervision authority: (b) merger with another financial institution:(c) take over by the bank supervision authority and subsequently resolved to the public .

These methods are important to insure that unsuccessful financial firms do not continue to risk depositors and government’s money,. The management of failed financial institutions should be fired or demoted.  However, the authorities have generally been permissive in allowing continued operation by existing management of the banks. It is important the inefficient banks be reduced in importance. new banks are needed to provide the necessary financial services while old inefficient banks strive to survive. If the  existing inefficient banks can reform themselves, then they can fight for market share with the new bank s. However, if inefficient, losing banks are left in the market without reduction in size, then the scope for new nanas is reduced and the financial system cannot be improved.

In conclusion, achievement of efficient financial intermediation requires three simultaneous conditions: (a) recognition as par to costs of bad debts and adequate return to capital by the banks: (b) profit maximizing behavior by financial institutions: and (c) effective supervision by the central bank to insure that the banks perform within the prescribed law.

 The Bangladesh Bank should be given responsibility for determining who should receive bank licenses. The issuance of new licenses should be determined with the objective of developing the financial system and should be made without the possibility of political interference. The choice that must be made by the political authorities is whether the nation wants a private, competitive banking system or a state owned system. Once this choice is made, it becomes the responsibility of the central bank to develop satisfactory commercial banking system. For a competitive system, the central bank determines the number of banks it believes appropriate and then awards licenses to achieve this target.

The management of granting licenses should be a routine procedure of the central bank. first, the BB should design agreeing system for applications which reflects the developmental objectives for the financial system. This grading  system should be approved by an appropriate committee to insure if reflects the intent of the government policy. Upon approval, this grading system should be promulgating to the general public.

Second, an application form should be designed, and this should include the following:(a) a business plan including projected balance sheet and profit and loss statement and branch plan:(b) sponsors and their financial history including reputation:(c) a plan for raising the requisite capital: (d) a demonstration of sufficient banking and business experience in the proposed managerial staff. Third, the BB would determine annually the number of new banks to be established during the year based on the need to increase capital in the banking system over the next few years. Finally, applications would be accepted up to a cut-off date and all such graded and ranked. Charters would be granted from the top with a minimum score needed, until the target number was marked or there were no more acceptable proposals.