Moody's Ratings downgraded Bangladesh's banking system outlook from stable to negative, citing rising asset risks and worsening economic conditions.

The report released today highlights key concerns including deteriorating asset quality, high inflation, and weakening economic growth, which will negatively impact banks' profitability and financial stability.

Moody's forecasts that Bangladesh's real GDP growth will slow to 4.5 percent in the fiscal year ending June 2025, from 5.8 percent the previous year.

"The operating environment will deteriorate due to economic slowdown and a high inflation rate," Moody's said.

The slowdown is driven by a combination of political and social instability, disruptions in supply chains within the garment sector, and weakening demand both domestically and internationally.

Furthermore, Bangladesh's central bank has raised policy rates from 6 percent to 10 percent over 15 months in an attempt to curb inflation, which is expected to remain high at 9.8 percent in 2025.

The report warns that Bangladesh's banking sector will face mounting asset risks as non-performing loans continue to rise.

As of September 2024, the systemwide NPL ratio had surged to 17 percent from 9 percent just nine months earlier.

"Asset quality will deteriorate as the operating environment worsens," Moody's said, adding that "social unrest has severely affected the financial stability of some domestic businesses by reducing demand, disrupting supply chains and creating labour shortages."

Additionally, new, stricter NPL classification rules taking effect in April 2025 could further exacerbate the situation, Moody's said.

Despite challenges, overall capitalisation is expected to remain stable due to slower credit growth.

However, state-owned banks remain particularly vulnerable, with an average capital-to-risk-weighted-assets ratio of -2.5 percent as of September 2024, well below the private sector average of 9.4 percent and regulatory minimums.

"State-owned banks will remain undercapitalised because of weak profitability that is strained by high levels of NPLs and the absence of government capital infusions," Moody's said.

Liquidity across the banking system is expected to be stable but tight, with the systemwide loan-to-deposit ratio standing at 81 percent as of September 2024.

Moody's acknowledges that the government is likely to continue supporting banks through regulatory forbearance and liquidity measures to lower "contagion risks".