How moral hazard has created a crisis in Bangladesh's banking industry
Moral hazard is an acute issue for Bangladesh's banking sector since it stimulates excessive risk-taking and compounds the overflow of non-performing loans
The banking industry in Bangladesh has expanded significantly in recent years, contributing significantly to the economic expansion of the nation. The rise in non-performing loans (NPLs) is a growing issue in the industry, though.
The risky loans in our banking industry totalled Tk3,77,922 crore by December 2022, according to the Bangladesh Bank's (BB) Financial Stability Report 2022.
Delinquent loans, which was Tk1,20,656 crore at the end of December 2022, increased to Tk1,31,620 crore by the end of March 2023. The total number of non-performing loans (NPLs), outstanding rescheduled and restructured loans, and loans that have been written off may have all been added together to arrive at this sum.
The concept of 'moral hazard' may very well be contributing to this situation.
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This article will explore the effects moral hazard has on the banking industry in Bangladesh and how it contributes to the escalating expenses associated with non-performing loans.
The concept of "moral hazard" in economics depicts a situation in which one party is shielded from the consequences of their decisions, potentially creating a conflict between individual and group interests.
When borrowers perceive that they are entitled to excessive risks because they believe the government or other institutions would save them in the event of a failure, a moral hazard is created. This view may encourage risky behaviour and careless lending practices, which in turn may increase the prevalence of non-performing loans.
There has always been a belief in Bangladesh that the government will step in to help distressed banks and borrowers, particularly those with political affiliations. This assumption causes a moral hazard since it encourages banks and borrowers to take on greater hazards in the hope of being saved during financial difficulties.
Inadequate regulatory supervision and enforcement could contribute to moral hazard in the banking industry. Financial institutions are encouraged to use risky lending practices while regulatory bodies are perceived to be inept or inefficient in enforcing prudential standards and pursuing misconduct.
Moral hazard can also be facilitated by the impact of politics on the banking industry. Politically influenced lending choices, where loans are granted to people or organisations based on political connections rather than creditworthiness, can lead to a greater proportion of non-performing loans.
The widespread prevalence of moral hazards in the banking system of Bangladesh has a number of adverse repercussions:
- The proportion of non-performing loans grows when banks and borrowers engage in greater risks in the belief that it provides a safety net. Banks' ability to lend money for useful reasons is diminished when loans are not returned as agreed upon, which hurts their financial stability.
- As depositors and investors start to worry about the safety and soundness of financial institutions, moral hazard erodes confidence in the banking system. Bank runs might result from this, which would destabilise the entire financial system.
- Financial instability might come from a high number of NPLs, since banks may need more capital to offset their losses. This might put a burden on the government's resources and invite macroeconomic challenges.
In Bangladesh's banking system, a number of measures could potentially be implemented in order to tackle the problem of moral hazard and their impacts on NPLs:
- Strengthening the regulatory framework and enforcement tools to guarantee that banks follow responsible lending and risk management requirements.
- Boosting transparency in lending selection and loan classifications to minimise the possibilities of political nepotism and meddling.
- Alert banks and borrowers on prudent financial practices, risk management, and the ramifications of moral hazard.
- Establish and practice reforms to eliminate political influence on banking decisions, and emphasise that loans are provided solely on creditworthiness rather than political ties.
- Moral hazard is an acute issue for Bangladesh's banking sector, since it stimulates excessive risk-taking and compounds the overflow of non-performing loans. A comprehensive approach that strengthens regulatory control, improves transparency and diminishes political influence in the banking industry must be implemented to address this issue.
By resolving moral hazard, Bangladesh may construct a more robust and resilient banking sector that will contribute to the country's economic development and growth.
SK Shamim Iqbal, a Certified Expert in Credit Management (CECM), is currently serving Social Islami Bank Limited (SIBL) as a faculty member at its training institute.
Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard.
