Banks to be in trouble if big borrowers default

Banks might plunge into a capital crisis if big borrowers default on loans, eventually leading the financial sector to an adverse condition, the Bangladesh Bank has warned in the Financial Stability Report for the second quarter (April-June) of 2020.

At the end of the second quarter, the banks saw some improvement in their financial health while the conditions of non-bank financial institutions (NBFIs) showed no progress, according to the report published on Tuesday.

However, the central bank thinks that the country's financial sector, in general, remained stable even at the time of the pandemic. Interest rates on lending and loan-deposit ratio or spread also declined in the second quarter of the year.

The report says the overall capital position in the banking sector has improved. The capital to risk-weighted asset ratio (CRAR) rose 28 basis points to 11.63%. At the end of June, 49 out of 58 banks managed to keep the minimum CRAR limit at 10%.

But, stress scenarios defined by default of top borrowers would have the most adverse effect on banks' capital position, in which case minor shock would result in the CRAR of the whole industry below the minimum requirement.

The report says NBFIs had mixed performances in the second quarter of this year. Return on assets (ROA) and return on equity (ROE) were 0.57% and 5.32%, respectively at the end of June. The ROA and ROE were 0.14% and 1.27% respectively at the end of March and 0.21% and 1.75% by the end of June last year.

Both capital adequacy ratio (CAR) and core capital ratio of financial institutions fell in the review quarter compared to the earlier quarter's, with CAR being 16.42% against the minimum requirement of 10.0% and core capital ratio being 14.63% against the minimum requirement of 5.0%. Pertinently, 27 out of 33 financial institutions maintained minimum CAR and 29 maintained core capital ratio.

Aggregate liquidity of financial institutions stood at a new level as the Bangladesh Bank lowered the cash reserve ratio (CRR) requirement to 1.5% from 2.5% in pursuant to alleviate Covid-19 shocks on market liquidity.

Quantitatively, total cash reserve of the industry decreased by 25.4% from the end-March 2020 quarter, recording at Tk6,148.2 million. Also, the amount of statutory liquidity ratio (SLR) decreased by 4.6% from the previous quarter but remained far above the minimum requirement.

According to the report, the amount of classified or default loans of NBFIs has increased significantly compared to those of banks. The default loans of NBFIs increased by 26.1% in the second quarter in contrast to the first quarter's.

It says more than 13% of the total loans became defaulted at the end of June, up from 10.98% at the end of March.

The report on the stability of banks noted that both assets and profits of banks decreased at the end of March – the month when the Covid-19 began its roundups in the country. However, the situation began to improve at the end of June.

The banks' investment in government bonds has increased while loan disbursement has also increased owing to the government-announced stimulus implementation.

However, gross non-performing loans (NPLs) increased by 0.2% at the end of June compared to March's figure. But, the amount of net NPL has started to decrease as the liquidity of banks has improved slightly at the end of June.

Overall, the banks' profit was better in June than in March.

Noting that the overall economy was stable at the time, the report said the average inflation rose to just 0.1% at the end of June because of rising food inflation. In the meantime, non-food inflation was stable.

On financial and economic stability during the pandemic, central bank Governor Fazle Kabir in the report said, "The banking sector in Bangladesh largely appeared to be resilient, owing to our various policy measures to keep the credit intermediation and payment services smooth and uninterrupted."

During the review period, the industry maintained a strong capital position, much higher than the minimum regulatory requirement. Because of easy monetary policy adopted by the Bangladesh Bank, no abrupt volatility was observed in the liquidity situation, according to the report.

As debt-servicing capacity of borrowers eroded amidst the Covid-19 crisis, banks' profitability was on a decline, while the gross NPL ratio decreased mainly due to the central bank's policy relaxation to tackle adverse impacts of Covid-19. Strict monitoring of stressed assets would be key to maintain asset quality once the relaxation is over.