Financial sector reform, believe it or not, has been almost something of an ever-present process in Bangladesh, particularly notable in the post-1991 era, as a transition (or was it just harmless flirtation?) to democracy paved the way for all sorts of interventions that were hitherto missing completely.

In fact, the original Bank Company Act of 1991 itself was a landmark reform for the country. But make no mistake, we were late coming to the party and there was a lot we had missed by way of advancement and sophistication in the financial sector. That in turn had also created the scope for various outlandish scams and general fraudulence that was practically unheard of, and over time these seemed to sprout exponentially.

What can be said with confidence is that opportunities for reform in the financial sector, including the laws that govern banks, have not been wanting. They keep coming along - what has harmed us is that the reform initiatives have often actually been detrimental or even retrogressive - taking us backward.

Now a new set of reforms are in the works, reportedly being pushed hard by the International Monetary Fund, the global lender on whose doorstep the government of Bangladesh turned up last July, coinciding with a sudden energy crisis that threatened to knock the wind out of the country's sails on its development journey.

The final impetus perhaps came when in the first week of March, the international credit rating agency, Moody's Investors Services, downgraded its outlook for Bangladesh's banking sector to 'negative' from 'stable' on the heels of various alleged scams, irregularities and the piling up of massive non-performing loans in the banking system.

In its report, published at the start of March, Moody's said that the outlook slid to negative as asset risks increased and the liquidity situation tightened in the country. Earlier in December, it had placed the Ba3 rating it had earmarked for long term issuer and senior unsecured ratings on review for downgrade.

The decision to place the ratings on review for downgrade was driven by Moody's assessment that Bangladesh's deteriorating external position raises external vulnerability and government liquidity risks in a way that may not be consistent with its current rating.

The assessment also reflects governance weaknesses in the ability of institutions to take credible measures to arrest the deterioration of reserves adequacy. While Moody's expects the agreement on the Extended Credit Facility/Extended Fund Facility and the Resilience and Sustainability Facility with the IMF to provide some external financing, programme conditions were yet to be finalised back then, so it waited until the loan was secured at the end of January, before going ahead with the downgrade.

Bangladesh's foreign exchange reserves are declining at a rapid pace, largely driven by rising costs for energy imports and moderating growth in export earnings. While the Taka devaluation and softening of some commodity prices could improve terms of trade in the medium-term, Moody's expects the energy crisis to exacerbate balance of payments and liquidity risks in the near-term.

Moody's also said the state's financing options remain narrow due to the absence of international issuance and limited domestic capital markets, while FDI are very limited. Although Bangladesh has modest debt payments due to the concessional nature of its external debt with long maturities, weak debt affordability-with interest payments absorbing a widening share of the government's narrow revenue base-poses further risks.

At the same time, the long-term ratings for seven Bangladeshi banks were also placed on review for downgrade at the same time as the decision to review Bangladesh's long-term rating. The seven banks are BRAC Bank, The City Bank, Dutch-Bangla Bank, Eastern Bank Limited, NCC Bank, The Premier Bank and Mercantile Bank.

The decision to place the ratings and assessments of the banks under review was driven by Moody's placement of Bangladesh's Ba3 sovereign rating under reassessment. Moody's also downgraded Social Islami Bank's long-term foreign currency deposit ratings from B2 to B3 and the bank's Baseline Credit Assessment to caa1 from b3. The rating outlooks were also changed to stable from negative.

The move in early March seemed to spare the sovereign, as Bangladesh retained its rating, but the banking sector as a whole was downgraded.

Readymade remedy

Then on March 29, as if out of nowhere, it was announced that the cabinet had approved the draft of the Bank Company (amendment) in bill form, where it limits the number of directors from a single family running a bank to three.

Currently, a maximum of four family members are allowed in a bank's board of directors, following one of those retrogressive reforms as recently as 2018.

Once the amendment is passed in parliament, there will be no more than three members from a family in the boards. Besides, the board members will need to put up collateral to avail loans (more below).

In the press briefing at the Secretariat, the cabinet secretary said there are 34 provisions in the draft bill. All, irrespective of board members or their relatives, must submit collateral for availing of loans.

For the first time ever, the bill seeks to define wilful defaulters and borrowers. If an individual does not repay the loan despite having the ability, resorts to fraudulence or fake information, and uses the amount for undeclared purposes, s/he will be defined as a habitual defaulter.

The secretary said the concerned bank will submit the list of wilful defaulters to the central bank and the latter will make arrangements to ban the concerned individuals from going abroad, ban their trade licence and company registration, etc.

If a habitual defaulter fails to repay loans within two months of receiving a notice, a process will be initiated to reclaim the money through the court. Also, if a bank does not submit the list of willful defaulters, the Bangladesh Bank may slap the bank with a fine ranging from Tk 5 to 10 million.

The cabinet meeting chaired by Prime Minister Sheikh Hasina gave the final approval to the draft after the IMF reportedly stipulated that the draft law should be tabled in the Jatiya Sangshad by next September.

The much-needed amendments to remove the legal grey areas and rein in bad loans have been in the process for years - the draft that finally got off its desk has been sitting there since at least 2021, with the central bank preparing it in 2020 and getting feedback from stakeholders. The draft seeks changes to a number of provisions of the 1991 Bank Company Act and inclusion of some new provisions.

The cabinet approval followed Bangladesh's renewed pledges for financial sector reforms made to the IMF, as part of the package of programmes under which it secured a $4.7 billion spread out over three years.

The Bank Company Act was amended back in 2013 too with tougher provisions for default loans and bank boards. But remarkably, those provisions were gradually relaxed on various occasions on a number of pretexts, leading to a cancer in banks' governance, and perhaps most glaringly, an absolute erosion of discipline in the sector.

Short on ambition?

The proposed Bank Company (Amendment) Act-2023 still falls short in some crucial ways though, and most economists consider these necessary to establish accountability and good governance in the banking sector.

The 'wilful defaulter' clause is arguably the most significant change we look poised to encounter, is welcomed by economists. Directors, equity holders and even businessmen in general, hate it though, and with a passion. Under the clause, such wilful defaulters can be subjected to various penalties. But how a wilful defaulter would ultimately be dealt with still leaves some scope for ambiguity and fails to meet international standards, according to experienced economists we spoke to this week.

Similarly the draft fails to adequately address the influence over decision making in a bank enjoyed by sponsor-directors or their families. These amendments hardly inspire confidence that it could lead to a significant turnaround in the state of the banking sector.

Single-family directors would still be able to control a bank through reciprocal understanding over time, precluding the bank's board of directors from performing its three main functions of protecting the interests of depositors, minimising loan defaults, and investing in ventures with good rate of returns through the loan approval and disbursement process.

They urged the government to define how wilful loan defaulters would be dealt with in accordance with international standards, and to reduce the number of single-family members allowed on the board to two with a maximum tenure of six years each, from the existing four with a maximum tenure of nine years each.

The draft proposes to bring it down to just three, while keeping the maximum length of their tenures unchanged at nine years.

Now or...maybe later?

Economist Dr Fahmida Khatun, executive director of the Centre for Policy Dialogue, a leading think tank that has been tracing the evolution of the banking industry and working with it from outside and within, remarked on record: "I think allowing two members of a family in the board of directors would be correct - I don't understand why it has been kept at three (in the draft act)."

When a bank is run by several members of the same family - there is virtually no obstacle to decision making by the director whose family dominates. Keeping this in mind, earlier the Bank Act of 1991 allowed just two directors from one family and banks were run better, she said.

"Basically, it was to ensure the internal good governance of the banks. The Banking Company (Amendment) Act-2023 may fail to deliver good governance due to a lack of desired reform," she said.

According to CPD, the amount of defaulted loans in the country's banking sector has more than tripled in the last ten years, from Tk 42,725 crore in 2012 to Tk 134,396 crore in the current fiscal, and is increasing gradually - the largest single indicator of the sheer burden that has to be borne for the mistakes of the past.

The trust of ordinary depositors may only be restored through reducing family authority in decision-making and exemplary punishment for defaulters and those who facilitated money laundering through forged loans.

Bank officials say that one of the major reasons for the rise in loan defaults is the approval of large loans to the private sector without due process or adequate verification of documents.

Bangladesh Bank has uncovered several instances of loans obtained through forged documents, often in the name of companies that don't exist.

Former IMF economist and executive director of the Policy Research Institute (PRI) Dr. Ahsan H Mansur is stern in his view that implementation, not mere legislation, is how the battle must be fought to provide Bangladesh a mature and capable financial sector that people can actually invest their faith in - this will require the wilful or habitual defaulters defined in the new law to be dealt with in exemplary fashion, through legislation that in fact prescribes to international best practices.

In the draft of the amended act, an individual will be considered a wilful defaulter if he or she does not repay a loan taken in their name or their company's name despite having the means to pay it back. In addition, any person will be treated as a habitual defaulter if he or she takes loans under the name of a non-existent company.

The persons who are deemed as wilful or habitual defaulters by the confirmation committee of banks can appeal to the central bank within 30 days from the submission date of their names.

The central bank will make the final decision on whether the aggrieved persons will be enlisted in the list of habitual defaulters, and this leaves scope for influence-peddling, it is felt.

"The risk can be understood by looking at the amount of defaulted loans of a country. Risk cannot be understood by defining it through your own chosen method instead of international standards. This will lead to a crisis of international acceptance for the banking sector," Dr Mansur, also the chairman of Brac Bank, added.

He thinks that there is still scope to amend the Act if the government wishes. The law should be brought up to international standard as Bangladesh's involvement is growing in international trade, Mansur said.

Former Governor of Bangladesh Bank Dr Salehuddin Ahmad said, "Different areas (of the bank) are controlled by the family and those who are in the management of the bank are also afraid of them (family members)."

If there are multiple board members of the same family, then there is no transparency and accountability in making decisions, he said.

Besides, if there is more than one bank under the ownership of the same family, the case of one bank taking benefits from another bank is also seen in Bangladesh, he pointed out.

"The directors of this bank will take favours from another bank, that bank will take favours again from another bank. This needs to be addressed," the ex-governor said.

Additional reporting by Anisul Islam