Banking sector at a crossroads

Recent bank failures in the US and Switzerland have raised many questions regarding bankers' role in the financial world. Questions are being asked: Can societies manage without banks even if their failure causes so much misery?

This is a legitimate concern. This perception is bankers' own creation. Bankers simply digressed from their core function, which is intermediation.

Intermediation, in the banking context, is an acquired skill whereby bankers manage funds to pay interest to depositors and to earn a little higher return through investments. Bankers execute this job through a process called "maturity transformation". Bankers always try to earn moderate but definite income through this method.

Looking into the investment activities of three recently failed banks, one can see how the market condition was changing while bankers were complacent. Silicon Valley Bank, in particular, relied heavily on government bonds investment, turning a blind eye to the prevailing fair value of the long-term bonds they held in their portfolio.

Credit Suisse digressed from conservative banking norms and invested heavily in private funds over which the bank had no oversight control.

While the western world suffers from overbearing management decisions and market risk, delinquencies in Bangladesh are mostly manmade. It is widely believed that the misuse especially of two financial products had largely damaged our banking sector.

In early 2000, there was a dearth of short-term liquidity, especially in the garment sector of Bangladesh. Therefore, bankers improvised factoring of receivables through local bill discounting. Simply defined, factoring is discounting of invoices/receivables for cash liquidity. This product did well at the beginning.

Soon, bankers themselves transformed this instrument into a fee-earning business. More bankers joined the profit mania. Soon the product transformed into an accommodation bill.

Conceptually, an accommodation bill is signing and accepting bills of exchange by two separate entities without any underlying value consideration. Bankers simulated this for a quick profit, while the scammers used it with ulterior motives.

Soon a well-designed financial instrument transformed into a deceptive tool. To stop this mischief from further damaging our banking sector, the Bangladesh Bank intervened.

Another area of concern has been import financing through loans against trust receipts (LTRs). In a working paper, the Bangladesh Bank said the major finding is that the LTR facility was misused. It was subject to malpractices by both banks and clients. A huge amount of LTR loans was stacked up and converted into term loans. A part of term loans was classified as non-performing loans which is a major concern for the central bank.

The current heaps of bad loans in the banking sector are largely the result of two misused facilities: accommodation bills and LTRs.

In a recent review, Bloomberg estimated $620 billion in unrealised losses in the US banking system. Experts believe that if this unrealised loss is adjusted with the shareholders' equity of respective banks, roughly 100 US banks will go burst.

Unrealised losses in Bangladesh's banking sector are never estimated. However, these potential losses are concealed in rescheduled loans, courts' injunctions on related loans, failed alternative dispute resolution (ADR), and provision shortfall.

The write-off facility is very often misused in our banking sector, yet it is a necessary evil.

During every crisis, central banks either rescue a bank or let it collapse. This is the horns of a dilemma for the central banks. Rescue causes complacency and hardline induces a chance of systemic risk. On the other hand, depositors stand at a crossroads not sure of the next path to follow.

The author is an independent director of Bank Asia Limited