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FINANCIAL SECTOR ASSESSMENT - BANGLADESH

MARCH 20 10

FINANCIAL AND PRIVATE SECTOR DEVELOPMENT VICE PRESIDENCY

THE WORLD BANK SOUTH ASIA REGION REGIONAL VICE PRESIDENCY

A joint IMF-World Bank team visited Bangladesh from July 19 to 30,2009 to update the findings o f the 2003 Financial Sector Assessment Program (FSAP).' This report summarizes the main findings o f the assessment update and the policy priorities identified, focusing on financial development issues.

The team comprised Robert Kahn (co-Lead, Wor ld Bank), Rodolfo Maino (co-Lead, IMF), Juan Buchenau, Mique l Dijkman, Olivier Hassler, Varsha Marathe, and Luchia Christova (all World Bank); Romain Veyrune, Moses Kitonga, and Elod Takats (all IMF), and James Hanson and Diane Mendoza (expert consultants). The mission was supported by Mr. Jonathan Dunn and Mr. Abul Quasem o f the IMF Resident Representative office in Dhaka and Mr. A.K.M. Abdullah o f the World Bank office in Dhaka.

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CONTENTS

I . Overall Assessment And Summary o f Main Recommendations ................................................ 1 I1 . Macroeconomic and Macro-financial Developments and Vulnerabilities ................................. 6 I11 . The Banking Sector ................................................................................................................... 6

A . Overall Developments in Banking ......................................................................................... 6 B . Banking System Structure, Performance, and Vulnerabilities., ............................................. 7 C . State-owned Banks ................................................................................................................. 9

I V . Financial System Development Priorities .............................................................................. 10 A . Access to Finance ................................................................................................................. 10 B . Capital Market Development ............................................................................................... 13 C . The Insurance Sector ............................................................................................................ 15 D . Housing Finance .................................................................................................................. 16 E . Payment and Settlement Systems ......................................................................................... 18

Boxes 1 . The State Commercial Bank Reform Program ...................................................... 9

Figures 1 . Deposits/GDP and Per Capita GDP. Selected Countries. 2007-08 .................................. 22

Tables 1 . Principal Recommendations of the FSAP Update .................................................. 5 2 . Size Distribution o f Microfinance Institutions ...................................................... 11 3 . Financial System Structure, Selected Sectors. 2001-02 and End-2008 .......................... 21

Appendixes 1 . Financial System Structure. Selected Sectors. 200 1-02 and End-2008 ......................... 21 2 . DepositdGDP and Per Capita GDP. Selected Countries. 2007-08 .............................. 22

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GLOSSARY

B A C H

BCA

BB

BHBFC

BCA

CDBL

CIB

DAD

DVP

FCB

FSAP

FY

GDP

ICAB

L L C

MFI

MoF

MRA

NGO

NPLs

N S S

SB

SCB

SEC

SMEs

SOE

Bangladesh Automatic Clearing House

Bank Companies Act

Bangladesh Bank

Bangladesh House Building Finance Corporation

Companies Act

Central Depository o f Bangladesh Limited

Credit Information Bureau

Deposit Accounts Department o f BB

Delivery versus Payment

Foreign Commercial Banks (branches o f foreign banks)

Financial Sector Assessment Program

fiscal year

gross domestic product

Institute o f Chartered Accountants

limited liability corporation

micro finance institution

Ministry o f Finance

Microfinance Regulatory Authority

nongovernmental organization

nonperforming loan ratios

National Savings Scheme

state-owned specialized bank (agriculture or industry)

state-owned commercial bank

Securities and Exchange Commission

small and medium enterprises

state-owned enterprise

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I. OVERALL ASSESSMENT AND SUMMARY OF MAIN RECOMMENDATIONS

1. and developed since 2003 against the backdrop of 6 percent average GDP growth. Banks’ total assets and private credit ratios to GDP have each increased by about one-third since the 2003 FSAP. Bank deposits, as a percentage o f GDP, are comparable to other South Asian countries. Private domestic banks now hold a majority o f bank assets; the shares o f state-owned commercial banks (SCBs) and specialized banks (SBs) have declined correspondingly. Bank branches, access to banking, and microfinance services have expanded substantially. Nonbanking financial institutions have also grown but remain small; banks s t i l l account for over 90 percent o f financial institutions’ assets. Equity market listings and capitalization have grown substantially; market capitalization was equivalent to about 14 percent o f GDP in December 2008. A government bond market i s developing. Further sound financial development in the various parts o f the financial sector, and increased access, would benefit from improvement in fundamentals: better credit information and improved legal and judicial enforcement o f creditors’ rights and collateral execution.

The Bangladesh financial system, particularly banking and microfinance, has grown

2. The banking system has been strengthened since the 2003 FSAP and proved resilient to the recent global financial turmoil. The banks’ stated capital position has improved. Reported nonperforming loan ratios (NPLs) have decreased substantially since 2003, to some extent because o f the growth in loans and GDP. Stress test results suggest that commercial banks would be resil ient to a moderate economic decline, but SCBs and SBs and some private banks would require capital injections under a more severe downturn. Although the SCBs remain weaker than private banks, their performance has improved under corporatization and a reform program that i s based on incentives and goals that are monitored by Bangladesh Bank (BB) and that was supported by the World Bank. An extension o f the program would be desirable to continue the progress o f the SCBs. The SBs remain weaker than the SCBs and subject to political pressures. Recent global financial problems have not affected the banking system much because o f both i t s l ow exposure to credit derivatives and foreign exchange products, which are limited by regulation, and the maintenance o f GDP growth. However, the economy i s potentially vulnerable to a protracted global slowdown or fall in remittances.

3. framework for banks, further improvement would be needed to bring the system up to international standards. Loan classification, provisioning, rescheduling, and even capital in banks appears uneven and needs strengthening to be brought to international standards. Exposure limits and treatment o f related parties-issues that are complicated by the problems in the registration o f companies-also need strengthening. BB’s initiatives to shift to risk-based supervision also need enhancement. In addition to tightening regulations and improving supervision, supervisory staffing needs to be strengthened and an expert cadre o f professionals retained. Finally, ad hoc government policies-such as those altering prudential actions o f BB,

Although the government has improved the prudential regulatory and supervisory

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interest rate ceilings, directed credit, or easing debt service for some economic sectors-would tend to put additional stress on banks, and in particular on the still-weak finances o f SCBs.

4. to deal with the rapid growth of new banking activities. Banks are rapidly increasing their involvement in capital markets: through lending and equity purchases, and through l i n k s to merchant bank and brokerage houses. Risks to capital from a fall in the market could weaken some banks. Banks also have increased exposure to microfinance institutions (MFIs). These changes increase the need for consolidated supervision and interaction among regulators. The associated market risks would require allocations o f additional capital as prescribed in Base1 11.

5. - Microfinance has doubled in size to about 3 percent o f GDP; improved credit information and regulation would support further sound growth. Better credit information would allow sounder lending by microfinance institutions and increased access to finance through the microfinance sector and banks. Managerial capacity in some MFIs, particularly the smaller ones, seems to be lagging, and some o f the institutions appear weak. In addition, some MFIs are expanding into areas traditionally reserved for banks. Although some o f these changes reflect desirable financial innovation, they also partly reflect differences in the regulatory and tax environment for banks and MFIs. These developments in the MFI sector represent potential future vulnerabilities for the financial sector and the economy as a whole. Although individual institutions are small, their problems could become contagious and could lead to political issues, given the numbers o f people involved. The regulation and supervision o f the MFIs i s being strengthened but will be challenged by the growth and complexity o f MFIs and their hnding- particularly the larger MFIs. The sector would benefit from a strengthening o f the Microfinance Regulatory Authority (MU) in terms o f resources, powers, and capacity. It also would be desirable to clarify MFIs’ activities and develop a procedure for convergence o f the regulation and supervision fiamework between large MFIs and banks. New enabling regulations would support access and financial development in areas l ike mobile phone transfers and nonbank financial networks.

BB’s regulatory and supervisory framework would also benefit from strengthening

6. debt market remains limited. Equity market capitalization reached about 14 percent o f GDP at the end o f 2008, compared to 2 percent in FY02; listings have increased by nearly 30 percent. A primary government debt market exists and i s developing, but the secondary market i s limited. The corporate bond and commercial paper markets have yet to develop.

The equity market has grown rapidly, especially between 2006 and 2008, but the

7. improved information, including accounting and auditing; further corporate governance reform; and improvement o f settlements. Demutualizing the exchanges may also be desirable. Better credit information and stronger audits would help both the rating agency and the development of the commercial paper and private bond markets. International accounting standards have been partially incorporated in Bangladesh and the accounting and auditing profession has benefitted from donor-supported programs. Nonetheless, auditing could be

Capital market development would benefit from better fundamentals such as

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improved: for example, by instituting reviews o f audits and placing reasonable limits on auditors’ performance o f non-audit services for clients. Recent steps to improve corporate government could be supported by further strengthening of shareholders rights, the independence and professionalism of board members, and enforcement capabilities o f the registrar o f corporations. Demutualization o f the markets could contribute to their development by improving the balance between the interests o f issuers/investors and brokers, and to better management and greater efficiency o f the exchanges.

8. cooperation between the SEC and BB, and enhancing BB’s treatment of banks’ involvement in the capital market would support sound growth in the market and the economy. The legal and regulatory framework for the securities market i s adequate, but enforcement i s lagging, in part due to a shortage o f resources and the regulator’s lack o f autonomy in the enforcement o f rules and administrative matters. The SEC needs to attract and retain professionals capable of monitoring and enforcing SEC regulations covering the various aspects o f a growing, increasingly complex marketplace. Providing the SEC with greater autonomy in budget, personnel, and rules enforcement would make it a more effective regulator. Cooperation between SEC and BB regulators should be improved to track the potential r isks between banks and related capital market f i r m s in the event o f market volatility. As noted, BB regulators and supervisors will need to better manage risks related to banks’ growing involvement in the equity market.

9. areas such as sales and brokerage practices, consumer protection, companies’ investment capital, and investment practices are needed. The Insurance Regulatory Authority Bill and the Insurance Bill introduced in Parliament in 2009 will set up an independent regulatory authority to monitor the insurance industry and raise the minimum paid-up capital requirements for insurance companies. Significant efforts will be needed to ensure the effectiveness o f these bills.

Strengthening the Securities and Exchange Commission (SEC), improving

The insurance sector i s small, but premiums are growing rapidly and regulations in

10. sector will depend on fundamental improvements in titling and registration o f property and in the legal and judicial enforcement o f mortgage contracts, as well as development o f long-term finance.

Growth o f housing finance has been limited. Increased nongovernment finance for the

1 1. implementation o f the new automated system and the Payments and Settlements Regulations; in addition, the legal framework and payments oversight may need strengthening, and settlements of large value payments and trade in government bills and bonds could be improved. There i s a legal risk that the use o f electronic facsimiles o f the checks will be challenged in the courts: for example, under the Negotiable Instruments Act. Settlement risks in large-value payments need to be reduced by additional systemic changes, such as implementation of real-time gross settlements. The government bills and bonds

Payments infrastructure has been improved and will benefit from full

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settlement could be enhanced by imp1ementing.a Delivery versus Payment (DVP) mechanism. Finally, the BB’s role in payment and settlement systems can be improved by formalizing i ts role in payment systems oversight, policies and tools. Strengthening the dialogue with stakeholders will greatly contribute to the success o f the reforms.

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TABLE 1. PRINCIPAL RECOMMENDATIONS OF THE FSAP UPDATE

Principal Recommendations TimeFrame I

Continue improving information collection and the use of the stress testing methodology.

Integrate stress test analysis with the supervisory function.

Replace interest rate ceilings, moral suasion, and directed credit with market-based incentives.

Near term

Near term

Medium term

Strengthen bank capital in line with banks’ r isks in the equity markets. Near term

Continue the reform of state-owned commercial banks (SCBs).

Establish a plan for improving the specialized banks (SBs).

Near term

Near term

Introduce a lender of last resort facility to provide liquidity to solvent banks at a penalty rate. Near te rm

Continue to strengthen BB by automating i t s operations, improving supervisory capacities (including more effective risk-based supervision), increasing transparency, enhancing disclosure policies, and providing it with greater independence and autonomy.

Improve assessment of banks’ risk profile, management, and governance and develop a clear, monitorable program for improvement in these areas. Establish a framework for bank participation in merchant banking and brokerage activities through legally separate entities.

Near term

Near term

Near term

Provide the SEC with greater autonomy in budget and personnel decisions and rules enforcement.

Set up a committee of stakeholders to develop a roadmap for demutualization o f the stock exchanges.

Near term

Near term

Strengthen the Microfinance Regulatory Authority’s resources, powers, and capacity. Develop prudential standards for MFIs and a roadmap for convergence o f standards for larger M F I s and banks.

Implement cost-effective regulations regarding mobile phone money transfers.

Near term Near term

Near term

Improve the credit information system and the legal execution of collateral to improve lending and access to finance. Review the legal framework and publish rules for the new automated system.

Encourage gradual replacement of checks with electronic credit and direct debit instruments.

Near term

Near term

Near term

Strengthen the legal and judicial enforcement o f mortgage rights and collateral. Overhaul the titling and land registration system.

Medium term Medium term

Near term: 6-12 months; Medium term: 12-24 months

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11. MACROECONOMIC AND MACRO-FINANCIAL DEVELOPMENTS AND VULNERABILITIES

12. Bangladesh’s macroeconomic performance has been good in recent years, despite natural disasters and volatile food and energy prices. GDP growth averaged over 6 percent annually from 2002 to 2008. Rapid export growth, large remittances, and strengthened policy frameworks and macroeconomic fundamentals bolstered growth and external stability; together with limited openness to short-term capital flows they sheltered the financial system and nonfinancial corporations from external shocks. External debt i s sustainable and largely concessional; gross international reserves rose from $1.7 bil l ion in 2002 to over $6 bi l l ion in 2008. The authorities responded to the global crisis with a stimulus package o f 0.6 percent o f GDP-largely funds and loan refinancing to small exporters and recapitalization o f financial institutions that focus on agriculture and rural development.

13. Bangladesh’s financial sector has avoided the global financial turmoil. Banks have low exposures to structured foreign exchange products and credit derivatives-with the exception o f some forward contracts. The low exposures reflect foreign exchange regulations. Off-balance sheet activities are typically small and mainly basic swap contracts that do not represent significant risks. External developments have not created asset quality problems nor precipitated a credit crunch.

14. commodity prices, and excess liquidity in the banking system. A “third wave” o f the global crisis, for example, slowing exports and remittances, would pose risks. A more fundamental issue i s that although remittances have remained strong-growing 22 percent in FY07/08-the recent decline in workers leaving the country may pose a future risk. Strong export earnings recently reflect shifts in demand in major export markets to the lower-end garments that Bangladesh produces. However, future export and GDP growth will depend on moving to more up-scale exports. Rising commodity prices could erode the recent improvement in the balance o f payments. Finally, excess liquidity arising from the strong balance o f payments, the relatively fixed exchange rate, and difficulties in sterilizing foreign exchange receipts could lead to inflationary pressures and then credit risks.

The major potential macroeconomic risks arise from remittances, export earnings,

111. THE BANKING SECTOR

A. Overall Developments in Banking

15. since 2001. Banking assets represent over 90 percent o f the assets in financial system institutions and are over four times equity market capitalization (Appendix 1). Banks are also beginning to get involved in the nonbank sector. Bank assets are now equivalent to 62 percent o f GDP compared to 47 percent in FY02; credit to the private sector i s now about 40 percent o f

The banking system still dominates the financial system and has grown substantially

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GDP compared to 30 percent in FY02.2 Bank deposits exceed 50 percent o f GDP, compared to 30 percent o f GDP in FY02. The deposit-to-GDP ratio i s large given Bangladesh’s per capita income and is comparable to South Asian nations. (Appendix 2).

16. the partial liberalization of interest rates- plus robust GDP growth, contributed to banks’ growth and strengthening. Bank profitability has risen and reported NPLs have declined. The nonbank sector and the equity market also benefited from these reforms.

Legal reforms, regulatory reforms, and liberalization in the 1990s-in particular,

B. Banking System Structure, Performance, and Vulnerabilities

17. Private domestic banks now hold 55 percent o f bank assets, compared to 35 percent in FY02 (Appendix 1). Private banks’ growth has been funded by rapid deposit growth; foreign borrowing i s not permitted. The growth o f Islamic banks also benefited from their handling o f rapidly growing remittances. On the asset side, unlike many countries, private banks’ retail credit grew slowly until r e ~ e n t l y . ~ Instead, the main sources o f private banks’ credit growth were rapid increases in traditional trade and working capital lending, as well as increased term loans to industry and lending to larger agricultural f i r m s and small and medium enterprises (SMEs) that were formerly the province o f SCBs. In addition, banks’ equity market related activities have increased recently.

18. The private domestic banks’ expansion reduced the role o f the SCBs substantially, although they still account for nearly 40 percent o f bank assets. The SCBs lost market share due to: (i) weak balance sheets that would not support rapid credit growth; (ii) slow growth o f SCBs’ traditional borrowers and their high N P L s ; ~ and (iii) the SCBs’ unresponsive business processes. In addition, SCB sector’s overall loan growth was limited administratively while one SCB awaited privatization and the others participated in the recent restructuring program. The market shares o f foreign banks and SBs have not changed much.

19. Commercial banks’ performance has improved on average, in the context o f continued rapid GDP growth, strengthened prudential regulation, and recent efforts to improve the SCBs. The reported average capital ratio i s now about 10 percent o f risk-weighted assets, roughly equal to the new minimum ~tandard.~ Reported classified assets are down compared to 2007, although they s t i l l represent a large 10.8 percent o f loans on average. The SCBs continue to have much higher NPLs than the private and foreign banks. N P L ratios have

IMF, International Financial Statistics. The init ial slow growth o f consumer credit also may reflect the regulatory stance earlier in the decade and the high

general provision (5 percent) for consumer credit. Mortgage lending has grown slowly, as discussed in Section IV. Borrowers with NPLs recorded in the Credit Information Bureau cannot borrow. Commercial banks have a 10 percent minimum capital adequacy requirement, ha l f o f which (5 percent) must be

Tier 1 capital, up from 9 percent and 4.5 percent in 2007. Tier 2 capital includes a general provision o f 1 percent for al l unclassified loans, except for (i) housing and SME lending (2 percent); and (ii) consumer credit and special mention loans (5 percent). High bank taxes (45 percent, compared to 35 percent for other f i rms) deter internally financed equity growth.

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been declining since 200 1 in all bank groups, albeit from a very high level.6 In part, this decline reflected the rapid growth o f lending and GDP. Coverage o f required provisions on reported NPLs has improved, though it remains less than 100 percent for private banks, on average. Stress test results suggest that commercial banks would be resil ient to a moderate economic decline, but SCBs and SBs and some private banks would require capital injections under a more severe downturn. It should be noted, however, that required provisions are low by international standard^,^ and delinquent loans can be re-categorized as performing loans fairly easily. This approach to loan classification delays recognition o f credit risk.

20. they still appear low by international standards and their dependence on the equity market may indicate that they are somewhat risky. Private and foreign banks earn higher rates o f return than SCBs, reflecting better loan origination and collection-and, recently, greater participation in activities related to the equity market. A fall in the equity market could reduce bank earnings and asset values substantially. To contain this risk, (i) additional capital should be allocated to the value at risk in the market, per Basel 11; (ii) banks’ risk management o f these activities should be improved; and (ii) consolidated supervision-including banks’ new capital market activities- should be strengthened, along with cooperation with other regulators.’

Average returns on assets and equity have increased for all types of banks, though

2 1. credit information and in the legal and judicial enforcement of creditor rights and collateral execution. The public Credit Information Bureau (CIB) suffers from several shortcomings, including lengthy and manual operational processes. Data should include credit histories, especially given the ease with which NPLs can be reclassified as performing. To increase access, data should include small loans. Enforcement o f collateral rights i s s t i l l lengthy, despite the existence o f the Money Loan Court. The government should investigate approaches to speed up enforcement o f collateral rights that have been used elsewhere, such as India and Mexico. Improvement in these areas will increase incentives for repayment, competition among banks for borrowers with good reputations, access to credit, and the quality o f bank loans.

The quality of lending and access to credit could be enhanced by improvements in

22. framework for banks, further improvement would be needed to bring the system up to international standards. Loan classification, provisioning, rescheduling, and even capital in banks appears uneven and needs strengthening to be brought to international standards. Exposure limits and treatment o f related parties-issues that are complicated by the problems in

Although the government has improved the prudential regulatory and supervisory

Average reported NPLs fel l from 41 percent o f loans in 200 1 to 10.8 percent in 2008. ’ Specific provisions o f 20 percent are required for non-term loans after debt service i s overdue for 6 months, 50 percent after 9 months, and 100 percent after 12 months. Term loans and loans to agriculture and SMEs-all o f which are important in SCBs and SBs-allow much longer periods o f loan delinquency before provisioning.

The authorities noted in their comments on this Update that capital charges on market risk exposures have been introduced with the implementation o f Basel I1 capital standards and on-site supervision examinations include assessing the processes and practices o f market risk management in the banks. Also, consolidated supervision w i l l be considered for those banks engaging in capital market operations through subsidiaries.

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the registration o f companies-also need strengthening. BB’ s initiatives to shif t to risk-based supervision need to be enhanced. Supervisory staffing needs to be strengthened and an expert cadre o f professionals retained.

23. credit generate inefficiencies and vulnerabilities for the banking sector- particularly the SCBs, which are more subject to government pressure. In the past, the government pressured banks to open low-cost lines o f credit for petroleum, fertilizer, and food during the oil/food price run-up. Recently, BB instituted interest rate ceilings on loans in the hope o f ensuring low-cost credit to certain sectors. The government has also tried to ensure credit and reduce debt service for some sectors through moral suasion and SCB lending. Interest rate ceilings lead banks to focus lending on the more creditworthy customers and limit loans to riskier borrowers, in particular small f i r m s and consumers for which there i s less credit information. Ceilings on loan rates also tend to decrease rates on deposits, as has occurred, which in turn may limit loanable funds. Directed credit forces banks to provide credit to inefficient borrowers, who often fail to service their debt, thereby leading to inefficient resource allocation, slower growth, and higher NPLs. The banking system and the economy function more efficiently if credit i s allocated by banks under strong prudential regulation, using market-based incentives.

Ad hoc government demands, interest rate ceilings, moral suasion, and directed

C. State-owned Banks

24. The SCBs have made progress, especially in reducing NPLs, but their average ratio of capital to risk-weighted assets i s still low and NPLs, despite a reduction, are higher than private banks. In the past, the SCBs suffered from large NPLs, reflecting not just their ineffective procedures for identifying borrowers, poor risk management, and weak collections, but pressures to make loans to and reduce debt service payments by certain sectors. The recent reported reduction in SCBs’ NPLs largely reflects a reduction in these pressures and the results o f the government’s restructuring program o f the SCBs that i s monitored by BB and supported by the World Bank (Box 1). The program focused on cash recovery o f NPLs and management improvement along monitorable lines, but it i s set to close at the end o f 2010. The notional addition to capital through an accounting increase in goodwill was more than double the then- book value o f capital, and did not improve the underlying strength o f the banks. However, capital will be strengthened over time to the extent that SCBs are profitable, by the use o f pre-tax profits to amortize the increase in goodwill. This approach will reduce reported profits o f SCBs.

Box 1. The State Commercial Bank Reform Program In 2007, the four SCBs were corporatized into limited liability corporations (LLCs), owned by a government holding company. The corporatization brought the SCBs under the BB’s regulatory authority, and was coupled with a notional accounting increase o f Taka 87.9 billion in goodwill/capital, equivalent to the SCBs’ accumulated losses. The SCBs are committed to using pretax “amortizations” to replace this notional capital increase over 10 years, and the 2008 “amortizations” were made. This procedure reduces reported earnings from the SCBs. In 2007, the government began a restructuring of three of the SCBs to operate along more commercial lines; these efforts were monitored by BB and supported by the World Bank For each bank, Chief

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Executive Officers andManaging Directors and four General Managers (Accounting, Audit, Information Technology, and Human Resources) were selected competitively and remunerated at private sector levels based on performance. Annual, monitorable goals were set for cash recovery of NPLs, limits on new NPLs, operations, computerization, profitability, increased net worth, and disclosure. These goals were almost wholly achieved in 2008 and in 2009. The average reported capital o f these banks i s now 10 percent. Voluntary retirement schemes are being formulated to reduce staff, but will require approval of the Ministry o f Finance. The banks have also been engaged in long-term planning, which will involve a careful consideration of the value of individual branches. The fourth SCB was targeted for privatization even before 2007, and i t s major activities were suspended for over two years, but the privatization did not occur. As a result, the bank’s operations and financial condition deteriorated significantly. The bank was added to the restructuring program, but i t s management was not changed as was done in the other SCBs. I t s performance has improved somewhat, but it remains exposed to unsecured credits to state-owned enterprises.

25. measures. These measures include: (i) continuing the SCB reform program, which i s about to expire, in particular the approach o f using monitorable targets and maintaining pay and incentives to attract and retain top quality management; (ii) improving the governance o f the SCBs further, with more independent and technically capable boards that are responsible for performance; and (iii) bringing the fourth SCB fully into the reform program. In addition, the government will also need to develop a long-run plan for the SCBs and their role in the financial system, which may include their eventual conversion into private ownership, and ensure that actions taken, such as sale o f minority ownership in the market, do not hinder the achievement o f the long- run goals.

The authorities could contain the risks posed by the SCBs through a variety o f

IV. FINANCIAL SYSTEM DEVELOPMENT PRIORITIES

A. Access to Finance

26. provide a wide array of services to a large proportion o f the population, and are an important tool for poverty alleviation. MFIs, banks, and government programs served 33 mi l l ion customers as o f December 2007. I t i s estimated that over hal f o f all poor households use MFIs’ wide range o f loans, basic and long-term savings (“retirement savings”), and insurance services. About 80 percent o f MFI members have active loans; the rest only maintain deposits.

MFI loans are equal to 3 percent o f GDP, twice the figure in FY02; the MFIs

27. majority o f financial services delivered through rural branches and in cash. Unlike banks, the branches o f MFIs and the Post Bank are concentrated in rural areas. Post branches deliver a limited range o f financial services (money orders and deposits) compared to MFIs. Automatic teller machines (ATMs) and point o f sale (POS) services are available only to a very few urban customers. Although automation i s improving, rural branches o f all types o f institutions are largely s t i l l not automated.

The microfinance industry encompasses more than 4,200 entities, with the vast

28. customers each) had 91 percent o f MFI deposits and provided 90 percent o f the outstanding loan

A few MFIs dominate the market. The 3 1 largest institutions (with more than 50,000

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volume as o f December 2007 (Table 2). The four largest institutions, each o f which i s comparable in size to a small or medium-sized bank, served over 75 percent o f a l l members.

Table 2. Size Distribution of Microfinance Institutions

Number o f Volume o f Participation in Volume of Share o f loans institutions savings savings loans (percent)

(million Tk.) (percent) (million Tk.)

Big 4 (Grameen, ASA, BRAC, Proshika) 4 47,207 78 100,314 75 Licensed NGOs (50,000-1,000,000 27 8,087 13 20,213 15 members) Licensed NGOs (up to 50,000 members) 396 5,153 9 12,848 10 Total 427 60,447 133,375 100 Source: Mission calculations based on data from Credit and Development Forum o f MFIs and Microfinance Regulatory Authority. Data as o f December 3 1, 2007.

29. banks, and donors), which represent 50 percent of funding. Member savings (24 percent), own resources (6 percent), and other sources (20 percent) account for the rest. MFIs are interested in expanding member and nonmember deposits, both to obtain more low-cost funding and to improve services to members.

The main sources of funds for the NGO-MFIs are loans from third parties (local

30. Most MFIs in Bangladesh operate as nongovernmental organizations (NGOs); the main exception i s Grameen, which operates under a special law. MFIs provide diverse financial services. Many offer micro-insurance. BRAC operates a bank. Some MFIs are interested in engaging in equity market activities. MFIs also undertake nonfinancial activities, such as providing health and education. The lack o f control o f many MFIs’ operations through clearly defined ownership i s an important deficiency that can affect their soundness. According to several sources, the management o f most small MFIs lacks the expertise and training to perform i t s duties well.

Governance, operations, and management quality vary substantially across MFIs.

3 1. information about an MFI’s financial operations cannot easily be disaggregated when it carries out other activities related to health or education. The quality o f information about the performance o f institutions decreases significantly with their size. Smaller institutions are either not audited at all or audited by f i r m s with l o w qualifications.

Deficient financial information on MFIs i s an important weakness in the sector. The

32. Although financial viability seems to have improved, it remains an issue for some MFIs. For example, 12 o f the 26 MFIs reporting data to the MIX Market in December 2007.had a negative return on assets, including one o f the largest MFIs. Financial problems in a typical MFI are not inherently a systemic issue because o f their small size and prohibition on nonmember deposits. Nonetheless, contagion could generate liquidity problems in other MFIs and lead to a political issue, given the number o f people involved. These problems would be

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worse if MFIs were allowed to take nonmember deposits without sufficient regulation and supervision.

33. MFIs are regulated and supervised mainly by the Microfinance Regulatory Authority (MU), which lacks sufficient resources to perform its functions. Grameen Bank, which operates under a special law, i s the only MFI supervised by BB. The MRA licenses MFIs and supervises them, but i s insufficiently staffed and resourced to supervise the large number o f MFIs under i ts purview, especially given their complex operation^.^ I t also lacks the technical capacity to effectively oversee the operations o f the larger, complex MFIs, some o f which are the size o f small banks. The government-sponsored PKSF Foundation-which accounts for almost 25 percent o f total funding for the sector-xercises close on- and off-site monitoring o f the over 200 MFIs it funds, thus partially compensating for the weak oversight by MRA. The MFI system also does not have a financial safety net (deposits are uninsured) or an appropriate framework to resolve any failure. As most MFIs are small, the lack o f regulation, supervision and deposit insurance in i tse l f does not pose risks to the financial system. Nonetheless, some MFIs are as large as small banks, and operate in a variety o f areas.

34. The regulatory border between MFIs and banks i s becoming increasingly porous, creating challenges for the MRA and BB. The limited regulation on and tax-free status o f MFIs create substantial opportunities for regulatory and tax arbitrage compared to banks. Thus banks are interested in entering microfinance. Banks are also lending to MFIs. At the same time, MFIs want to have bank status so they can take deposits legally from nonmembers and undertake activities in the capital market and insurance. It would also be advisable to reconsider regulations concerning taxation that apply to banks and MFIs to reduce distortions and arbitrage. It also would be desirable for both the MRA and BB to improve the regulation o f MFIs, strengthen their capacity to oversee microfinance institutions, and design a road map for a sliding scale for convergence between MFI and banking regulation as an MFI becomes larger.

35. reduced by broader coverage in the Credit Information Bureau (CIB). Currently, loans granted by MFIs and small loans from banks are not recorded in the CIB. Since the focus o f the CIB i s bank risk. No t surprisingly, there are no data on payments to public services, which are often included in private credit bureaus in other countries and thus provide ways for first-time loan applicants to establish credibility. The lack o f credit information limits access to finance, and reduces incentives to repay loans to build a sound credit record. It also increases the

Access to finance through MFIs, and banks could be improved and lending risks

MRA oversees the operation o f 3,650 NGO-MFIs with a total staff o f 47 persons. After i ts creation in 2006, MRA took on the task o f making an inventory and licensing the NGO-MFIs. As o f December 2008, the M R A had licensed 402 entities, had 485 applications under process, and had rejected 604 applications o f MFIs without a regular office. Some 2,749 small entities were granted an extension to fulfill basic criteria until June 2009. MRA only performs off-site supervision, for which it relies on semi-annual, self-reported information o f the MFIs and on available yearly audit reports. It has developed standard terms o f reference for audits. I t plans to begin on-site supervision visits.

9

13

potential risk in loans o f MFIs and small loans by banks, because the debt service history o f loan applicants cannot be verified.

36. remittances would benefit from implementation of regulations establishing principles for transfers through mobile phones and nonbank agent networks." In addition, more bank branches and MFIs need to be computerized and linked to payments networks to increase availability o f these services. Gradually these developments would make better financial services available to the rural population. At the same time, they would increase the pressure for MFIs to take nonmember deposits and therefore increase the need for better information about and regulation o f MFIs.

Increased access to financial services as well as lower costs for sending and receiving

B. Capital Market Development

37 . The Bangladesh equity market-with separate exchanges in Dhaka and Chittagong-has increased sharply in capitalization, listings, and turnover since 2003, especially between 2006 and 2008." The market capita1ization:GDP ratio was about 14 percent at the end o f 2008, compared to 2 percent in FY02; listings increased by nearly 30 percent. From 2006 to 2008 market capitalization nearly quadrupled and listings rose 7 percent.

38. The debt market i s mainly a primary government debt market. A Treasury bill market i s active and the Central Depository o f Bangladesh Ltd. (CDBL) l i n k s banks participating in auctions and trading and provides the infrastructure for Bangladesh Bank's electronic registry. Government bonds (with maturities o f 5, 10, 15, and 20 years) are listed on the Dhaka Stock Exchange and dematerialized in the CDBL. Trading in government bonds i s small, almost entirely an over-the-counter phone market, mainly between banks, and i s settled bilaterally in the depository. The commercial paper and corporate bond market have yet to develop.

39 . The equity market i s dominated by local financial institutions both in terms of listings and holdings, and the listed companies are small. Financial sector stocks (banks, insurance, and investment companies) dominate the market and constitute about 47 percent o f the market capitalization; manufacturing stocks are 28 percent, and services sector stocks, including real estate and private power company stocks, are 25 percent. Banks and their clients are important investors in the market; nonbank institutional investors are too small to play a major role in the market. Foreign portfolio investment in Bangladesh i s only about 1 percent o f the market capitalization, although Bangladesh has liberalized i t s foreign investment legislation. The lack o f foreign investment may reflect foreign investors concerns about foreign exchange controls. It also may reflect the small size o f the market, compared to other emerging markets, and the small size o f the average listed company. Both o f these factors imply liquidity issues for

lo BB's 2009 Payments and Settlement System Regulation opens the possibility for mobile phone providers and other companies to act as Payments Service Providers. About 46 million mobile phones are used in Bangladesh, although al l o f them will not be able to use the mobile payments system, as many use pre-paid phone chips.

Figures are for the Dhaka exchange; the f m s listed on the Chittagong Exchange are similar. 11

14

local investors and especially for foreign investors, who have stimulated market growth elsewhere

40. Despite the performance o f the equity market, concerns exist about its possible volatility, its potential impact on banks, and the regulator’s capacity to supervise a rapidly growing market and the associated growth in brokerage houses and merchant banks. These concerns have been increased by the advent o f margin lending and the entry o f several banks into direct stock purchases. The entry o f banks into l i n k s with merchant banking and brokerage business has created competition with the traditional f i r m s and raised issues o f consolidated supervision. In addition, as with mutualized exchanges markets worldwide, the different incentives facing the ownershrokers and the investors have the potential to create problems in the markets.

41. intermediaries, listed companies, and mutual funds to protect the interest o f investors, but the massive changes in the market have reduced its effectiveness. The SEC’s budget, salaries, and personnel decisions are under the control o f the Ministry o f Finance (MoF), which has responded slowly to the rapid change in the market. The boom in the market has created a demand for SEC staffers. I t also requires rapid action-which may then be overruled by the government.

The Securities and Exchange Commission (SEC) regulates the exchanges, market

42. Capital market development can be advanced by further improvements in accounting and auditing as well as the aforementioned improvements in credit information. International standards for accounting and auditing have been partially incorporated into local standards. The development o f the accounting and auditing profession has been assisted by a wide-ranging, donor-supported program. Nonetheless, steps could be taken to raise audit quality, beginning with reviews o f audits on listed companies by peer reviewers or the regulators. Reasonable limits should be placed on auditors performing nonaudit services for their clients. The Institute o f Chartered Accountants o f Bangladesh (ICAB) should continue i t s efforts to police misconduct by i ts members and adopt a Code o f Ethics. The proposed Financial Reporting Commission should also be established, especially if I C A B does not make greater efforts to police i t s members. Development o f the rating agency, based on better accounting and credit information, would make investment in the capital market more attractive.

43. by further changes that would both stimulate the capital market and contribute to economic development.12 In 2006, the SEC issued Guidelines on Corporate Governance and i s now working to apply them to a variety o f companies. The Bangladesh Enterprise Institute provides director training to board members in listed companies and state-owned enterprises (SOEs). Despite these achievements, the basic legal framework for corporate governance in

Bangladesh’s recent steps to improve corporate governance could be complemented

l2 World Bank, Report on the Observance of Standards and Codes (ROSC): Corporate Governance Country Assessment, Bangladesh, March 2009.

15

Bangladesh i s dated, and contradictions and points o f confusion exist between the various rules and regulations that apply to l isted companies. Shareholders do not have sufficient rights regarding related party transactions, the choice o f board members, or the disclosure o f control. Greater independence and professionalism i s required in the boardrooms o f both listed companies and SOEs. Neither the Registrar o f Joint Stock Companies nor the courts are particularly effective at enforcing the Companies Act. The Registrar should undertake reforms to allow it to better fulfill i t s legal obligations and improve the disclosure o f corporate control, as noted above. A new Companies Act may be needed to remove various contradictions in the legal framework and strengthen shareholders’ rights and directors’ accountability. Any reforms to the Companies Act should be supported by an update to the Corporate Governance Guidelines.

44. enhancing BB’s treatment of banks’ involvement in the capital market will support sound growth in finance and the economy. The legal and regulatory framework for the securities market i s adequate, but enforcement i s lagging, in part due to a shortage o f resources and the regulator’s lack o f autonomy in enforcement o f rules and administrative matters. The current structure o f the SEC has contributed to difficulties in attracting and retaining professionals with a strong capacity to monitor and enforce SEC regulations in a growing, increasingly complex market place. Providing the SEC with greater autonomy in budget, personnel, and rules enforcement will make it a more effective regulator. Remuneration at the SEC should be comparable to BB; looking further ahead, market salaries should increasingly be the reference point for SEC professionals. Cooperation between SEC and BB regulators should be improved to track the risks in the l i n k s between banks and their capital market intermediaries in the event o f market volatility. As noted, BB regulators and supervisors will need to the manage risks related to banks’ involvement in the equity market.

Strengthening the SEC, improving cooperation between the SEC and BB, and

45. Demutualization of equity markets would contribute to their development. Demutualization i s likely to: (i) improve the balance between the interests o f issuershnvestors and those o f brokers; (ii) promote efficient and professional management that attracts a broader group o f market participants; and (iii) generate a greater degree o f automation in settlements and day-to-day management o f the exchange, leading to improved efficiency and transparency.

46. Improvements in the government bond market would start the process toward development of the commercial paper and corporate bond market. One area for improvement in this market, as wel l as in the equity market, i s in payments and settlement. Another i s better information, which would help the development o f the rating agency. Experience in other countries shows that the development o f long-term bond markets depends on development o f long-term investors, such as pension funds and insurance companies.

C. The Insurance Sector

47. remains small. There are 62 insurance companies in Bangladesh, which include two state-

The insurance sector-life, nonlife, and micro- insuranceis growing rapidly but

16

owned insurance corporations, one for l i f e insurance and one for nonlife, general insurance; 43 private general insurance companies; and 17 private l i fe insurance companies. Forty-one o f the 62 companies are listed on the Dhaka Stock Exchange. Three l i fe and three nonlife companies were licensed in 2000 under the Insurance Act 1938 to offer Islamic insurance products. A growing subsector i s micro-insurance. Almost every l i f e insurance company in Bangladesh offers at least one micro-insurance product, and micro-insurance accounts for a large share o f premiums of some companies. The two state-owned insurance companies account for around 15 percent o f premium income in their respective subsectors. Both l i f e and nonlife sectors are experiencing growth rates o f 15-20 percent annually. However, assets represent only 0.7 percent o f GDP.

48. This fast-growing sector can pose significant challenges for a regulatory framework that the government i s trying to set up. Private insurance companies are currently regulated by the Office o f the Chief Controller o f Insurance, in the Ministry o f Commerce, under the Insurance Act of 1938. The state-owned insurance corporations are regulated by the government under the Insurance Corporation Act 1973. Apart from sales and brokerage practices in the insurance industry, key areas o f concern relate to consumer protection, availability o f robust demographic statistics for actuarial computations, investment regulations for insurance companies, and professional management o f investment funds. In order to regulate the insurance sector better, two bills were introduced in Parliament in 2009: the Insurance Regulatory Authority Bill and the Insurance Bill. These bills will pave the way for an independent regulatory authority for insurance and raise the minimum paid-in capital requirements for insurance companies. Significant efforts will be needed to ensure a strong regulatory and supervisory capacity.

D. Housing Finance

49. urbanization pressures. Housing development i s hampered by the extent o f poverty and high housing prices due to constraints on housing supply o f housing and land. Between the poor, for whom some microfinance i s available, and the higher end o f the income distribution, which often does not need to borrow to invest, about hal f o f the population remains underserved by housing finance. l3

50. June 2008, as against 2.2 percent in 2002. Housing credit now represents 7.5 percent o f the private sector credit.14 The cash economy remains a major source o f real estate investment.

5 1. government support, and access to funding. The traditional lender, the Bangladesh House Building Finance Corporation (BHBFC), controlled by the MoF, i s weak financially and relies on recoveries to support i t s activity. I t s market share fe l l from 48 percent to 17 percent from

Mobilizing resources for housing investments i s critical, given demographic and

Housing finance i s limited. Housing loans outstanding reached 2.6 percent o f GDP in

Housing finance i s fragmented, reflecting differences in regulatory treatment,

Rental housing offers a solution that i s largely used in Dhaka. Excluding microfinance.

13

14

17

200 1 to 2008. Commercial banks, among which private institutions are the most active, represent about 60 percent o f the market. Three private specialized nonbank financial institutions (NBFIs) are the most efficient and dynamic actors, but are handicapped by limited internal funding bases. Loans currently offered are now typically for 15 years, a significant improvement compared to the norm o f 10 years ago. Loans remain expensive, however. Interest rates (adjustable to lenders' cost o f funds) range from 13 percent to 16 percent. BHBFC charges lower, administratively set rates, which do not target lower-income groups. In rural areas, MFIs' lending for housing has been developing, mainly from Grameen Bank. BB manages a program to support housing loans offered by NGOs. MFIs provide ten times as many loans as BHBFC but for very small amounts, at a rate (8 percent) that implies cross-product subsidization, Specific schemes complement market rnechanism~,'~ but would need to be made more market friendly to support further development o f housing finance.

52. market: (i) weak titling and registration; and (ii) weak legal and judicial enforcement o f collateral. Titling issues, in turn, are plagued by four main sets o f problems. Legal issues include the use o f power o f attorneys as a transfer instrument and inefficiencies in the leasehold system. Institutional issues are related to the dispersion of registries, transaction deeds, rights records, and physical data bases among different agencies, generate discrepancies, delays, legal insecurity, and opportunities for fraud. Operational issues include weaknesses in the safety and integrity o f records, which are manually maintained, and the slow speed o f registration. Finally, transaction costs are high-about 16 percent o f the value o f a property16--and serve as a deterrent to registration o f ownership and security rights. Properties remain unregistered, litigation i s widespread, land information i s not always reliable, price dissimulation is endemic, and incentives for various malpractices exist. However, some progress in titling i s underway. A 2004 amendment to the land law made registration a condition o f the validity o f rights. The Ministry o f Land i s working on computerization. Scanning o f registries i s on-going in Dhaka. The 2009/20 10 National Budget provides for a reduction o f registration costs to 8 percent and a streamlining o f registrations.

Two issues limit the mortgage market and mobilization o f funding from the capital

53. Enforcement o f mortgage rights and ability to evict defaulters remains weak. Despite the creation o f Money Loan Courts (1990), judicial execution i s cumbersome and can take more than ten years. A direct sale route i s available, but it allows frivolous challenges and i s l i t t le used. The underdevelopment o f the second-hand property market also contributes to making mortgage collateral l i t t le more than a tool o f moral suasion.

54. limits the availability o f maturity matching resources and fixed rate lending. Some long-term

Another constraint i s the lack o f long-term funding. The underdeveloped bond market

~ ~~

These are: (i) the National Housing Authority, a state agency that builds housing and provides long-term credit at below-market conditions to their buyers; and (ii) housing benefits provided by many employers, especially in the public sector. A Tk5 billion public program, run by BB, refinances mortgage loans with a 9 percent cap that targets intermediate income groups. More than 30 lending institutions participate, but i ts small size limits i t s impact. l6 The taxation basis i s an administrative value, generally below the market value.

15

18

savings are available in life insurance companies, employer-related provident funds, and the National Savings Scheme (NSS), but they mainly fund the government. The lack o f bridging solutions between the needs and the sources o f long-term funding reflects: (i) investment regulations and policies that channel savings toward government needs and induce reverse term transformation by institutional investors that receive longer-term finds but invest a significant part o f their portfolios in bank deposits; and (ii) the absence o f adequate investment instruments.

55. unlikely to mobilize substantial resources. Several private placements o f securitized instruments have occurred, but none have involved mortgages. Banks, which would represent the major investors given the structure o f the financial system, would need a regulatory BB framework. More fundamentally, basic elements for mortgage instruments are lacking, such as enforcement o f collateral, weak titles, and an historic record o f borrowers’ behavior, as noted.

The possibility of securitization exists under a 2004 SEC framework, but it i s

56. the fundamentals of mortgages: the legal and judicial enforcement of mortgage rights and collateral and the titling and land registration system. Supporting elements would involve creating a level playing field among the various institutions and restructuring BHBFC as a more market-based institution. As the fiscal position improves, diversification o f institutional and N S S portfolios could be allowed to go into bonds and mortgage instruments.

A comprehensive strategy to increase housing finance would begin by strengthening

E. Payment and Settlement Systems

57. system since the 2003 FSAP, but challenges remain. The BB has launched a project for automation o f check clearing and electronic credit and direct debit transfers that i s in an advanced stage o f implementation. The BB board also approved new payment and settlement systems regulations, and a new Payment Systems Division has been established at BB. The BB leads a high-level National Payment System Council, which was established to support the development o f payment, clearing, and settlement systems in Bangladesh and to serve as a forum for cooperation in domestic and international payment matters.

The BB has undertaken steps to modernize and improve the national payment

58. dominates payments by individuals. Checks are used for interbank market transactions, government payments, and commercial transactions. Checks and other cashless instruments (such as pay orders, bank drafts, and money orders) are paper-based.

Cash and checks are the main means of making payments in Bangladesh. Cash

59. inefficient and poses considerable settlement and operational risks. Interbank checks are cleared in the Bangladesh Bank Check Clearing House. The system i s based on physical exchange o f checks: all o f the processes, including the collection and submission o f checks by banks, are manual and paper-based. Calculated multilateral net debit positions o f participants in the BB check clearing are settled in accounts that they maintain with the Bangladesh Bank. Both

The interbank check clearing system in operation at the time of the FSAP mission i s

19

retail checks and customer large-value checks are processed through the system. Check clearing i s decentralized: the BB Dhaka City Clearing House and the seven BB branches across the country process clearings separately. Each commercial bank branch operating in the BB’s seven branches i s required to maintain a current account in each BB branch for clearing and settlement purposes. In addition, the BB has authorized state-owned Sonali Bank to act as a check clearing and settlement institution in areas without BB branches. In 2008, 16.44 mi l l ion instruments (checks, drafts, and pay orders) with a value o f Tk. 4,300 bi l l ion were cleared through the Dhaka Clearing House, about 75 percent o f the total volume o f checks. The BB branches and Sonali Bank processed 15 percent and 10 percent, respectively.

60. i s in place at the BB, and has problems similar to those at the Clearing House. Interbank payments arising f iom transactions in the money market, government securities market, rep0 operations, the Taka leg o f foreign exchange transactions, and the debit positions from BB check clearing are settled manually in the Deposit Accounts Department (DAD) o f BB. The settlement involves several BB departments, i s cumbersome, and sometimes results in errors and settlement delays. The number o f large value payments daily can exceed 2,000 (large-value payments processed through both the Clearing House and the DAD) and i s l ikely to increase with the development o f the financial markets. The BB also provides a foreign exchange clearing system.

A manual, paper-based procedure for same-day settlement o f large-value payments

61. The transactions and infrastructure for payments with debit and credit cards are growing rapidly in Bangladesh, although from a very low level. Debit and credit cards are mostly used to withdraw cash f iom ATMs. There are several payment switches for processing card payment in Bangladesh. The largest one (Q-cash) provides an integrated platform for 25 banks, and another two banks operate their own switches, which are interoperable with Q-cash. ATMs and POS terminals are concentrated in Dhaka and Chittagong. Recently, the banks have been expanding their services to customers by introducing new payment channels and services (internet banking, mobile banking, and cash deposit machines).

62. The BB i s in an advanced stage of implementing the Bangladesh Automatic Clearing House (BACH), a centralized automated system for processing and clearing of electronic payment instruments that will reduce settlement and operational risk. In the first phase, the current manual, paper-based check clearing will be replaced by the Bangladesh Automated Check Processing Service, an electronic clearing service based on check imaging and truncation for the Dhaka region. This system will allow for automated, same day settlement o f high-value checks and next day (T+l) settlement for other checks. In the second stage, the system will offer clearing o f electronic credit and direct debit instruments in a Bangladesh Electronic Funds Transfer Network, which will further reduce settlement risk and promote modern payment instruments.

63. legal framework and payments oversight may need strengthening, and settlements of large value payments and government bills and bonds trades could be enhanced. A legal risk

Full implementation of the BACH automated system i s a priority; in addition the

20

may exist that the use o f electronic facsimiles o f the checks will be challenged in the courts: for example, under the Negotiable Instruments Act. The new Payment and Settlement Systems Regulations may not prevent this, Settlement risks in large-value payments need to be reduced by additional system changes, such as real-time gross settlement. Settlement o f government bills and bonds trades would be enhanced by implementing a DVP mechanism. The BB’s role in payment and settlement systems would be improved by formalizing its oversight, policies, and tools. Strengthening the dialogue with stakeholders would contribute to the success o f the reforms.

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APPENDIX 1

Table 3. Financial System Structure, Selected Sectors, 2001/02 and end-2008

200 1/02 Percent

o f banking Percent

B i l l i on system o f GDP Number Taka assets a

Scheduled banks

State-owned

Commercial (SCBs)

Specialized banks (SBs)

Private commercial Domestic Foreign

Finance companies

Microfinance institutions b,

- 51

- 9

4

5

- 42 30 12

26

624

1.276.5

742.2

591.5

150.7

534.3 446.4

87.9

18.8

37.9

1oo.o

58.1

46.3

11.8

41.9 35.0 6.9

46.8

27.2

21.7

5.5

19.6 16.4 3.2

0.7

1.4 Securities markets 23 0 65.5 2.4

End 2008

Percent o f

banking Percent o f B i l l i on system GDP

b umber Taka assets

48

- 9

4

5

- 39

30 9

29 e

4,200

3.378.2

1.253.2

1,030.9

222.3

2,124.9 1,852.9

272.0

90.2

162.0 294 789.4

1oo.o

37.1

30.5

6.6

62.9 54.8 8.1

62.0

23.0

18.9

4.1

39.0 34.0 5.0

1.7

3.0 14.4

Source: Bangladesh Bank, Ministry of Commerce, Securities and Exchange Commission, Development Credit Forum, and M U .

a. Based on 2001/02 GDP o f Tk. 2,727 billion, 2008 estimated GDP o f Tk. 5,458 billion. b. Microfinance NGOs plus Grameen Bank. c. Total loans outstanding used as total assets. d. Dhaka Stock Exchange market capitalization in assets column. Listed f m s shown under number o f f m s ; excludes

e. Nonbank financial intermediaries. mutual funds.

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APPENDIX 2

Figure 1. Deposits/GDP and Per Capita GDP, Selected Countries, 2007/2008

Deposits/GDP and Per Capita GDP, Selected Countries, 2007/2008

Sources: IMF, International Financial Statistics, World Bank, Per Capita Income at Purchasing Power Parity Tables.