Banker Yunus's big challenge: Bangladeshis are defaulting on loans like never before

Bangladesh’s banking sector is currently facing a crisis of unprecedented proportions marked by an alarming surge in default loans. As of June 2024, default loans have soared to a record high of Tk 211,391 crore, up from Tk 182,295 crore just three months earlier. This staggering increase in non-performing loans (NPLs) reflects a growing vulnerability within the country’s financial system with NPLs now constituting 12.56 per cent of all disbursed loans. The implications of this trend are profound, signalling deep-seated issues that could undermine the stability of the entire economy if left unaddressed.

Systemic issues driving default culture

The root causes of the soaring default loans in Bangladesh are manifold with systemic issues within the banking sector playing a crucial role. A critical factor contributing to the crisis is the flawed redefinition of default loans by regulatory authorities. This redefinition has effectively obscured the true extent of the problem, allowing banks to underreport their NPLs and creating a false sense of security within the financial system. As a result, the scale of the crisis has only become apparent as the situation has continued to deteriorate.

More from World

Nepal's new PM pays homage to people died during the Gen Z protest in her first national address This Week in Explainers: How recovering from Gen-Z protests is a Himalayan task for Nepal

Economist Birupaksha Paul highlighted the role of defaulter-friendly policies in exacerbating the crisis in a piece for The Daily Star. These policies, which include a lending rate cap that disproportionately favours the wealthy, have created an environment where defaulters are often shielded from accountability. The result is a banking culture that is increasingly tolerant of defaulting borrowers, further weakening the financial system and undermining the principles of responsible lending. This environment has emboldened defaulters leading to a vicious cycle where bad loans beget more bad loans, eroding the overall health of the banking sector.

The crisis is not only rooted in the banking system’s internal challenges but has also been exacerbated by external pressures. Default loans in the banking system surpassed Tk 200,000 crore for the first time underlining the fragile condition of the sector under the tenure of the Awami League government over the past 16 years.

Impact Shorts

More Shorts

‘The cries of this widow will echo’: In first public remarks, Erika Kirk warns Charlie’s killers they’ve ‘unleashed a fire’

Trump urges Nato to back sanctions on Russia, calls for 50–100% tariffs on China

Till June last year, default loans stood at Tk 156,039 crore, Bangladesh Bank data showed.

When the Awami League secured its first of four consecutive election victories in 2008, bad loans in the banking sector amounted to Tk 22,480 crore. However, this figure began to escalate as irregularities increasingly plagued the financial system. As of the end of June, default loans at state-run banks stood at Tk 102,483 crore, which accounts for 32.77 per cent of their disbursed loans. Bad loans were likely to increase in the July-September quarter.

A The Daily Star report said that this is because a large volume of loans would rapidly sour as those loans were taken by influential business groups through fake documents and irregularities using their political clout when the Awami League government was in power. Moreover, there is a tendency among borrowers to refrain from repaying loans citing unfavourable economic conditions, which may add to the burden of bad loans. Most loans disbursed by state-run banks were also availed through unscrupulous, which makes it difficult to recover those loans.

Economic pressures exacerbating crisis

In addition to systemic issues within the banking sector, broader economic pressures are also contributing to the surge in default loans. Bangladesh’s economy has been grappling with a severe dollar shortage, which has placed significant strain on businesses that rely on imports for their operations. The resulting disruptions in supply chains have made it increasingly difficult for companies to generate the revenue needed to service their debts leading to a spike in loan defaults.

The dollar shortage has had a particularly pronounced impact on key industries such as textiles and garments, which are the backbone of Bangladesh’s export economy. With foreign exchange reserves dwindling, companies in these sectors have struggled to import raw materials, resulting in production slowdowns and revenue shortfalls. These challenges have been compounded by rising inflation, which has increased the cost of doing business and further squeezed profit margins. For many businesses, the combination of these factors has proven insurmountable, leading to an increase in loan defaults as they are unable to meet their financial obligations.

Strain on banking sector stability

Stressed assets, including written-off and rescheduled loans, stood at Tk 377,922 crore till December 2022, central bank data showed. The central bank has refrained from publishing data on written-off and rescheduled loans since. The former government had set a target to reduce the volume of bad loans as prescribed by the IMF with its $4.7 billion loan programme. As per the previous government’s directive, the Bangladesh Bank fixed a target to reduce bad loans at state-run banks to 10 per cent by 2026. The target for private commercial banks was set at 5 per cent.

The surge in default loans has also exposed significant weaknesses in the banking sector’s ability to absorb financial shocks. One of the most telling indicators of this vulnerability is the growing provision shortfall across the sector. By the end of 2023, the provision shortfall had increased by Tk 8,200 crore, signalling that banks are struggling to maintain adequate reserves against potential losses from bad loans. This shortfall is particularly acute among state-owned banks, which have been hardest hit by the rise in NPLs.

State-owned banks, which play a pivotal role in Bangladesh’s financial system, are facing a severe liquidity crunch as a result of the escalating default crisis. These institutions, which are often seen as lenders of last resort, are now grappling with a dual challenge: they must manage the immediate impact of rising NPLs while also preparing for future economic shocks. The growing provision shortfall suggests that many of these banks are ill-prepared to weather such shocks, raising concerns about their long-term viability.

The implications of this shortfall are far-reaching. Without sufficient provisions, banks are left vulnerable to further losses, which could trigger a cascade of defaults and ultimately threaten the stability of the entire financial system. Moreover, the provision shortfall is likely to constrain the ability of banks to extend new loans, further stifling economic growth and exacerbating the challenges faced by businesses already struggling under the weight of the current crisis.

Yunus’s role amid economic turmoil

Amid this financial turmoil, Nobel laureate Muhammad Yunus has emerged as a key figure in advocating for much-needed reforms within Bangladesh’s banking sector. Yunus, known for his pioneering work in microfinance and his commitment to financial inclusivity, now faces the daunting task of addressing the systemic issues that have contributed to the current crisis. His efforts to promote responsible banking practices are particularly critical at this juncture, as the sector’s vulnerabilities threaten to undermine broader economic stability.

Yunus’s advocacy for financial reform is not new, but the urgency of his message has intensified in light of the current crisis. He has long warned of the dangers posed by an unchecked default culture and has called for stronger regulatory oversight to curb the excesses that have plagued the banking sector. His calls for reform have taken on added significance as the scale of the crisis has become more apparent with default loans reaching unprecedented levels and the provision shortfall continuing to grow.

Yunus’s role is not limited to advocating for reform. As a trusted figure whether in matters of governance or of the economy, he is well-positioned to play a pivotal role in forging the consensus needed to implement meaningful changes. His efforts to bring together stakeholders from across the political and economic spectrum will be crucial in ensuring that the necessary reforms are not only enacted but also effectively enforced.

International concerns and need for reforms

The crisis in Bangladesh’s banking sector has also drawn the attention of international ratings agencies and financial institutions, which have raised alarms about the potential for further deterioration. The World Bank, in particular, has expressed concerns about the growing volume of NPLs and their potential to exacerbate financial sector vulnerabilities. These warnings have been echoed by other ratings agencies, which have highlighted the need for stronger regulatory oversight and more robust financial reforms to address the systemic issues that have contributed to the crisis.

The concerns raised by international observers are not without merit. The growing provision shortfall and the rise in NPLs are clear indicators that the banking sector is under significant strain and the potential for a broader economic slowdown is a real and pressing threat. The situation is further complicated by the fact that many of the underlying issues such as the flawed redefinition of default loans and the defaulter-friendly policies, are deeply entrenched and will require a concerted effort to address.

Path forward

The path forward for Bangladesh’s banking sector is fraught with challenges, but it is also clear that comprehensive reforms are urgently needed. These reforms must address the root causes of the current crisis including the flawed regulatory framework that has allowed default loans to reach such alarming levels. A key priority must be to enhance accountability for defaulters ensuring that they are not shielded from the consequences of their actions. This will require a rethinking of current policies including the lending rate cap, which has disproportionately benefited the wealthy and contributed to the default culture.

In addition to regulatory reforms, there is a pressing need to strengthen the resilience of the banking sector by addressing the growing provision shortfall. Banks must be required to maintain adequate reserves against potential losses, and state-owned banks, in particular, must be given the tools they need to manage their liquidity challenges. This may require a combination of capital injections, stricter oversight, and a more prudent approach to lending.

As Bangladesh navigates the challenges ahead, the collaboration between the government, the central bank and financial institutions will be crucial. The success of these efforts will depend not only on the willingness of these stakeholders to work together but also on their ability to implement the necessary reforms with urgency and determination. For Muhammad Yunus, the challenge is not just to advocate for change but to help guide the country through a period of profound economic uncertainty ensuring that the banking sector emerges from this crisis stronger and more resilient than before.