The outlook for banks in Bangladesh is stable over the next 12-18 months because of the healthy operating environment, and despite legacy asset quality issues and tighter liquidity conditions, according to a report on Moody’s website yesterday.

On the operating environment for banks, Moody’s says that Bangladesh’s economic growth is high and stable, underpinned by robust private investment and consumption growth. Private investment growth averaged 16 per cent between 2014 and 2016. Private consumption growth was also healthy, averaging 11 per cent over the same period, driven by rising income levels.

Moody’s also points out that the banks’ credit growth registered a healthy 16 per cent in the 12 months to 30 March 2017.

“This pace of loan growth is in line with Bangladesh’s underlying economic growth, and translates to a loan growth multiplier (loan growth/nominal GDP growth) of 1.1x,” says Srikanth Vadlamani, a Moody’s vice president and senior credit officer. “We expect that the banks will achieve loan growth in the mid-teens in 2018.”

Term loans made to industries are a key driver of overall loan growth, in line with the robust underlying investment cycle. Loans to the construction and infrastructure sectors, in particular, have been strong, and Moody’s expects this situation to continue.

Retail loan growth has also been picking up, although from a low base. Moody’s says that retail loan growth should strengthen, as more banks start focusing on this segment.

“Asset quality will remain a credit weakness for the banks, in particular for state-owned banks, over the next 12-18 months, primarily driven by corporate loan delinquencies,” says Komaresan Subramanian, a Moody’s Associate Analyst. “And, while liquidity conditions are comfortable, a rising loan to deposit trend poses a risk to the private sector banks’ liquidity profiles.”

Moody’s conclusions are contained in its just-released report on banks in Bangladesh, titled “Banking System Outlook - Bangladesh”, and is authored by Vadlamani and Subramanian.

On asset quality, Moody’s says that the banks, in particular state-owned banks, will demonstrate weak asset quality over the next 12-18 months. The gross nonperforming loan (NPL) ratio for Bangladesh’s banking system was weak at 10.1 per cent at 30 June 2017, a slight deterioration from the prior year.

NPLs for private sector banks remain elevated at around 5.5 per cent -6.0 per cent of gross loans. And, state-owned banks continue to suffer from acute asset quality issues, with a gross NPL ratio of 26.8 per cent at the end of June 2017. Moody’s also explains that the concentration of loans to conglomerates remains high, and represents a key structural risk to the banks’ credit profiles.

As for capitalisation, Moody’s says that the banks’ capital levels should deteriorate mildly, due to faster loan growth and reduced profitability. And, while the private sector banks demonstrate adequate capitalisation, state-owned banks’ capital levels remain very weak, with a capital adequacy ratio of 7.0 per cent at 30 June 2017.

On funding and liquidity, Moody’s says that the banks are increasingly reliant on market funds, with loan to deposit ratios rising for private sector banks, because loan growth has consistently outpaced deposit growth over the past three years.

With profitability and efficiency, Moody’s says that credit costs pose a drag on profitability. In particular, the returns on average assets for private sector banks will stabilise at low levels, reflecting elevated credit costs, which climbed to 30 per cent -35 per cent of pre-provision income following tightened rescheduling rules in 2012.

Moody’s expects that credit costs will stay elevated over the next 12-18 months, as some rescheduled loans become nonperforming; thereby necessitating a corresponding amount of provisioning.

Net interest margin and core profitability will remain stable for private sector banks, with stronger loan demand to support loan yields and net interest income.