Banking industry during and after the pandemic

We are all aware of the current condition of our country as well as the world due to the COVID-19. In this crisis, in an appreciable and timely measure, the government is trying to help the enterprises through different stimulus packages.

But how are banks or the money market going to survive during pandemic and afterwards? They are also like enterprises.

There are some critical issues and challenges that our banking industry is going to face.

Banks have to maintain the asset-liability position to manage liquidity versus profitability position.

Surplus Economic Unit (from which banks get money in the form of FDR and other form of saving instruments) is going to dry up if the economic crisis prolongs. Many of them will go for encashing their deposits and such economic condition rarely allows banks to get new depositors, which certainly reduces the cash inflow of the banks.

On the other hand, banks' liquidity must be ensured for their existence as banks must honour all the encashment of FD and other obligations on demand.

Moreover, banks will have to continue their lending operations, along with an additional BDT50,000 crore stimulus package, managing from their owned fund.

Going forward, it will be very difficult for banks to manage asset-liability mismatch. Though curtailing CRR to 4 percent gives some breathing space but specialists demand that it won't be sufficient. It will definitely have an adverse effect on our private sector credit growth as well as other economic indicators.

Senior bankers of the industry are apprehensive about the profit of banks in 2020. A bank's profitability depends on some major issues i.e. interest spread, percentage of non-performing loans/assets, non-funded income and cost to income ratio.

Interest spread was one of the burning issues in banking industry before pandemic as the central bank asked all commercial banks to set loan interest at 9 percent from April 2020.

Specialists in this sector believe that it is very difficult for banks – if they can take a deposit at 6 percent – to maintain profitability by lending at 9 percent and having only 3 percent spread.

Still many banks have to offer more than 6 percent to attract the depositors and in this case, the actual spread becomes 2 percent or less.

The depositors also compare the higher rate of National Savings Certificate as obviously they are not happy with 6 percent rate whereas they get around 10 percent in savings certificate as risk-free rate of return.

Moreover, Banks have to maintain AD ratio as they cannot lend their whole money from deposit collection.

Now, what is the impact of this 9 percent lending cap on banks' profitability? As per industry insiders, around 50 percent profit has been declined by this decision in April 2020.

Then comes another new blow to banks' profitability as they would not ask borrowers for interests for April and May and would have to keep the interests in a blocked account. Banking industry has to keep aside around 14000 crores in block account.

According to bankers and experts, many banks will end the year as loss-making concerns due to this decision. I would like to quote from a popular newspaper on this issue: "Another old bank with nearly Tk30,000 crore deposits has to pay off depositors around Tk300 crore for these two months. But the bank could not realize a single penny from Tk450 crore interests during the period."

Can you now imagine the situation of new banks with comparatively lower balance sheet size?

There are various tools suggested by economists to reduce interest rate i.e. reducing bank rate, reformation of banking industry and stop issuing saving certificate at higher rate.

Many specialists – normally outsider of banking industry – pointed that 4 percent to 5 percent interest spread in our country is pretty high. It is around 2 percent to 2.5 percent in many other economies.

Actually, banks' profitability is not only dependent on spread but also highly dependent on quality of assets or minimum non-performing loans (NPL).

The economies that are keeping lower interest spread are also maintaining their NPL at a very minimum level.

But as our NPL is more than 10 percent, it will be very difficult for our banks to maintain their profitability with 2 percent spread while provisioning for huge non-performing loans that hamper banks' profitability.

Moreover, we all know how difficult it is to get the money back from the defaulted clients. And the law of liquidating collateral against the loans obviously takes a long process. 

Some measures can be taken to ensure proper implementation of a reduced interest rate in the economy. As suggested by the economists, reducing bank rate, stop issuing of saving certificates in a higher rate than what the banks offered to depositors and the law of banking regulations especially for default loan management should be revamped.

We know, many wilful defaulters are living in our country – like nothing happens – but the banks are losing money. We may know what happened to the defaulted clients in China.

The Chinese government restricted the defaulters from travelling in the air, high-speed trains, staying at luxury hotels, enrolling their children at expensive schools and even their pictures were circulated along with identities like advertisement as social harassment.

In our country, on the other hand, defaulters can easily make foreign trips and participate in various amusements whatever they want.

Along with reformations, the credit culture of banks is also very important thing to minimize the NPL ratio.

Full empowerment of credit personnel is very important and the board should not force to proceed any loan proposal. Good governance with good credit culture can prevent this scenario from happening.

Banks also have non-funded income (NFI) along with interest income booked in income statement. But what is happening now as economic activities are largely affected along with international transactions certainly reduces the NFI of Banks and strikes negatively to the profitability.

We can predict now that things will never be the same as before after the pandemic. So policies should be taken in such a way where all the stakeholders of the industry will be benefited. 

Banks have to maintain their infrastructures – which are maintained by a large group of employees in each branch with banking activities all over the country. It also incurs a huge operating cost.

There is a popular ratio to define costing against income known as cost-to-income ratio. For instance, 47 percent cost to income ratio of a bank means that the bank has to spend Tk 47 to generate Tk 100 operating income.

This ratio varies from bank to bank based on a number of factors including a bank's business model, its size and the overall investment climate of a country and others. Cost to income ratio in banking industry varies from 35 percent to around 70 percent. Bangladesh Bank has already issued a circular regarding reduction of cost to commercial banks.

However, now, if we let our industry down, what the probable consequences will be?

• If banks' income is downsized, Board of Directors (BoD) definitely will not be happy to see the results. The management will try to minimize the costing and in the worst case, it may be decided for laying off, retrenchment or other measures based on the strength of balance sheet size.
• Now, think about the market capitalization of banking industry. When investors will observe that banks are not doing well. They will obviously sell their holding share and a huge price fall may occur which downsizes the banking industry market cap significantly.
• When this news will be public, depositors will also be reluctant to deposit in banks.
• Each year, the government receives a good amount of tax revenues from the banking industry. So, the government will lose tax revenues if we let the industry fall.
• Our banking industry makes around 25,000 crore operating profits. Due to reduced lending rate, transferring interest to blocked account and the current pandemic, some of the specialists predict that the profitability may be reduced by 50 percent this year.

Now think about the international rating of our banks and banking industry. When international rating will be downgraded, foreign banks will either deny our LC confirmation or charge higher fees which would adversely affect our international transactions, Balance of Payment (BoP), foreign currency exposure as well as foreign currency reserve.

Our economic activities are largely dependent on banking industry. Banking industry is the life line of our economy and we should not let this industry fall. Policies should be taken accordingly before it gets too late.

The author is a Credit Manager of a leading NBFI in Bangladesh.