22 banks face capital shortfall if top 3 borrowers default

Highlights:

• A portion of the investment from bank entrepreneurs and that from profits are reserved as capital 
• A bank with a capital shortfall cannot pay dividends to its shareholders 
• In addition, foreign banks take into account the capital situation of local banks before doing business with them
• 22 banks to face capital shortfall if top 3 borrowers default

Twenty-two banks will fail to maintain the minimum required Capital to Risk-weighted Assets Ratio (CRAR) if their top three borrowers default, according to the Bangladesh Bank's Financial Stability Assessment Report for 2022.

The CRAR is the ratio of a bank's capital to its risk-weighted assets and current liabilities.

As per international rules, banks are bound to preserve capital. According to the "Basel 3" policy, lenders in Bangladesh need 10% of their risk-weighted assets or Tk400 crore, whichever is higher, in preserved capital. If a bank fails to maintain the prescribed amount, it is considered to be in a capital shortfall.

According to the report, at the end of December 2022, in the pre-shock scenario, 11 scheduled banks could not maintain the minimum required CRAR. Moreover, five additional banks were not able to maintain the Capital Conservation Buffer (CCB) of 2.50% with an existing CRAR.

Under this stress scenario, considering the default of the top three large borrowers, 11 more banks would become non-compliant in maintaining the minimum required CRAR.

Moreover, a significant number of banks would experience a notable decline in the CRAR. In particular, 19 banks would experience more than a 5% decline in the CRAR for this shock. The banking sector would remain resilient in end-December 2022 with an after-shock CRAR of 10.11%, the report said.

A portion of the investment from bank entrepreneurs and that from profits are reserved as capital. A bank with a capital shortfall cannot pay dividends to its shareholders. In addition, foreign banks take into account the capital situation of local banks before doing business with them.

Dr Salehuddin Ahmed, a former governor of the Bangladesh Bank, told The Business Standard, "One of the keys to assessing the condition of a bank is its capital. A bank is in a capital shortfall means its asset quality is not good. Hence, the bank cannot lend. These types of banks are characterised as weak and they cannot properly return customer deposits."

A stress test on banks overall performing loans, considering a 3% increase in NPLs, indicates a significant impact on the capital adequacy ratios of an individual bank, as well as the banking sector. 

The pre-shock and after-shock CRAR indicate that the banking sector's CRAR would have declined to 9.82% from an existing level of 11.83% for a 3% increase in NPLs at end-December 2022 if the shock materialised. 

Under this stress scenario, additional four banks would become non-compliant in maintaining the minimum capital requirement. In addition, a significant number of banks would experience a notable decline in the CRAR. In particular, five banks would experience more than 250 basis points decline in the CRAR for a 3% increase in NPLs.

In case of combined shock (summation of shock results of Increase in NPLs, Fall in the FSV of Collateral, Negative Shift in NPL categories, Interest Rate Shock, Exchange Rate Shock, and Equity Price Shock), the banking sector's CRAR would likely decrease to 7.44% from existing 11.83%.

Arfan Ali, former managing director of Bank Asia, told The Business Standard, "If a customer needs a large amount and long-term loan, then he/she should sell his company's shares in the stock market. However, here we have huge loans taken from banks. This has increased the overall risk of the banking sector."

In response to the question of why the banks would face a capital shortfall if top three borrowers default, the seasoned banker said, "Instead of giving small amounts of loans to small and medium enterprise (SMEs) or other sectors, banks have given a large portion of loans to some big customers. Because of this, banks are at such risk. From this, it can also be said that the balance sheets of the banks are not well structured."

According to the report, in end-December 2022, the stress test results of non-bank financial Institutions (NBFIs) indicate that 14 out of 35 Institutions were in "sound" condition and seven were in "moderate" condition. In contrast, 14 financial institutions were in "weak" condition during the same period.