Financial institutions

“No need for so many non-banking financial institutions”

NBFIs are losing control of their customer base. The Business Standard spoke to Dr Saleh Uddin Ahmed, the former Governor of Bangladesh Bank, for a clearer view of the implications of the situation

15 February 2022, 12:00

Last modification: February 15, 2022, 5:01 PM

Illustration: TBS

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Illustration: TBS

Non-banking financial institutions – commonly referred to as NBFIs – ​​may have been exposed to market volatility due to their overreliance on a small number of large investors and debtors.

According to Bangladesh Bank, 56.2% of all deposits in NBFIs were between Tk 1 crore and Tk 50 crore. Additionally, only 5,019 depositors in the entire NBFI facility were responsible for these deposits. In terms of loans, 60.6% of total funds were distributed among only 6,587 borrowers.

Experts fear that if a large portion of these large depositors withdraw their funds for an unforeseen economic shock (such as the Covid-19 pandemic) or a decline in confidence in the market, NBFIs could face a liquidity crisis.

Given the rather controversial track record of NBFIs, these fears may not be entirely unwarranted. For example, in 2019, People’s Leasing and Financial Services (PLFS), a non-banking financial institution, narrowly avoided liquidation due to a High Court order ignoring a central bank plea.

Previously, the government of Bangladesh ordered the central bank to liquidate the NBFI for deteriorating financial performance for prolonged periods.

Additionally, in 2021, Bangladesh Bank said that 13 of the 34 NBFIs currently operating in Bangladesh had moved into the red zone by the end of 2020. The number was 10 in 2019.

Generally, the infection rate, defined as the ratio between non-performing loans and total loans distributed, is the main indicator for classifying financial institutions into three zones: red, yellow and green, the colors corresponding respectively to low, moderate and satisfactory performance.

Experts cite systemic issues such as a high degree of non-performing loans and lack of central bank oversight as some of the problems plaguing the NBFI sector.

The commercial standard wanted to gain a deeper understanding of the inner workings of the NBFI industry and look for a potential way out for NBFIs. So we asked Dr. Saleh Uddin Ahmedthe former governor of Bangladesh Bank, to share his two cents on the matter.

Dr. Saleh Uddin Ahmed, former Governor of Bangladesh Bank. Illustration: TBS

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Dr. Saleh Uddin Ahmed, former Governor of Bangladesh Bank.  Illustration: TBS

Dr. Saleh Uddin Ahmed, former Governor of Bangladesh Bank. Illustration: TBS

After four decades of operation, the lending and borrowing activities of NBFIs remain confined to a few thousand large debtors and creditors. Why have NBFIs not been able to expand their operations to the degree expected?

This problem is not exclusive to non-banking financial institutions. All financial institutions, banking or non-banking, are overexposed. Whether banks or NBFIs, the main problem is their tendency to chase after large debtors and creditors while ignoring small business debtors.

They do this because by distributing large amounts of loans to a small number of customers, they hope to maintain control while generating a considerable amount of revenue with very little effort. While large banks have the capacity to monitor their debtors, most NBFIs have limited resources and cannot do so. This is probably why they prefer to keep a relatively smaller and manageable list compared to typical financial institutions like banks.

According to Bangladesh Bank, 56% of all deposits in NBFIs belong to just 5,019 creditors. It is feared that a large withdrawal of these deposits or the inability of large debtors to repay their loans could leave the NBFIs vulnerable to possible shocks. Is this fear reasonable?

NBFIs are currently held hostage by large debtors. They understand that financial institutions depend on them for lending and borrowing. As a result, debtors tend to take out several different loans from different financial institutions at different times.

For example, if they had to repay their loans from one bank, they would take another large loan from an NBFI to repay the other. NBFIs cannot do anything about this as they have to compete with other financial institutions to get these customers and their reluctance to comply with customer demand would scare away customers.

Moreover, most NBFIs – ​​even if they were willing to do so – do not have the capacity or the human resources to follow up their clients. To make matters worse, there are numerous reports of irregularities within the establishment of the NBFI, such as the corruption of their administrators or their involvement in shady practices. All of these factors together have exposed these institutions to the risks you mentioned.

Do you think that recent scandals in the banking industry as well as in the NBFI industry, such as the liquidation of People’s Leasing and Financial Services (PLF), have damaged customer confidence in NBFIs?

There are too many NBFIs currently operating in Bangladesh. But people only know and trust a handful of them. Either they’ve never heard of the others, or they don’t trust their operations.

Also, NBFIs are not as strictly regulated by Bangladesh Bank as other financial institutions. They are not required to strictly adhere to the CRR (Cash Reserve Ratio: the percentage of total funds that a financial institution is required to keep in cash to avoid a liquidity crisis) announced by the central bank.

In short, typical financial industry standards don’t always apply to them. This is another reason why creditors don’t trust them very much. Scandals such as the liquidation of the PLFS only aggravate this situation.

Bangladesh Bank says the biggest failure of NBFIs is to release timely products. Do you agree?

Currently, there is no market for so many NBFIs in Bangladesh and most of these institutions are not even trying to diversify their products or introduce packages that would attract new clients and expand the market. From the start, they should have focused their operations to serve small and medium-sized businesses. But instead, they take the easy way out by picking and choosing some big debtors and creditors to run their operations and generate revenue.

These NBFIs do not diversify their portfolio and pursue other risk compensation measures such as hedging (a risk management strategy that offsets losses by taking an opposite position in a related asset), risk sharing and debt securitization. In short, they diversify neither their clientele nor their products. They put all their eggs in one basket and we are now seeing the outcome of that decision.

In addition to this, many banks have invested large sums of money in NBFIs and due to their poor performance, many banks have also been exposed to the risk of these NBFIs going bankrupt.

How can the NBFI sector reach its true potential? What measures should be taken by the central bank and the GOB to achieve this goal?

There are many NBFIs in name only, which do not contribute much to the financial sector. When I was governor of Bangladesh Bank, I saw that many of these NBFIs could not even pay their employees’ salaries properly. So I would recommend removing the license from these institutions and merging those with poor performance with larger ones with better track records.

In the case of large financial institutions in difficulty, get them out of this situation and restructure their management. Some may argue in favor of liquidation, but such measures will not solve the problem.

The next step would be to improve the financial management and financial reporting system. Assuming financial institutions exercise prudent management and reporting, they can release shares on the stock market to increase their capital base. Without the injection of new capital, it is unlikely that the NBFIs will be able to grow beyond their current capacity.