Bank Sector Update - Nine New Banks for Bangladesh - February 2012
BackgroundOn April 4, 2012, the Bangladesh Bank (BB) approved three new banks, thesponsors of all of which are Non-resident Bangladeshis. Following this sixmore banks were approved on April 8, 2012. The six most recently approvedwere drawn from a short-list of 16, of a total of 37 applications. Meanwhile, thethree approved Non-resident Bangladeshis bank applications were drawnfrom a pool of five Non-resident Bangladeshis bank applicants.Since mid-2011, the issue of setting up new banks has been a topic of muchdebate in local print and broadcast media. On September 27, 2011, BB hadissued a circular, seeking applications for new banks. Applicationrequirements included a paid-up capital of BDT 4 billion to be paid byshareholders, caps on proportion of share ownership per shareholder,stipulations on size of the board, a squeaky clean credit history (no record ofloan default in last five years) to list a few.The primary role of the Non-resident Bangladeshis Banks, as envisioned byBB, will include inwards remittance of foreign currency, attracting tradecustomers, and creating FDI inflow into Bangladesh by raising funds from thelarge but widely dispersed Non-resident Bangladeshisis population. Theincreasing importance of inward remittances from the Bangladesh diasporawas highlighted in an earlier report.Analysts:Sajid Huq Amitsajid.email@example.comFarjad Siddiquifarjad.firstname.lastname@example.orgBank Sector Update: Nine New Banks forBangladeshApril 09, 2012Figure 1: Country-wise count of scheduled banks1020304050Bangladesh* Pakistan Nigeria KenyaNumber Scheduled of Banks* The existing bank count stood at 47 prior to these approvalsSource: Bangladesh Bank, Central Bank of Nigeria, State Bank of Pakistan and Central Bank of Kenya
Bank Sector Update: Nine New Banks forBangladeshIn fact, it was not clear last year if more than a few bank licenses wouldbe approved. International Financial Institutions discouraged theformation of new banks; given the sector already has 47 scheduledbanks, 30 of which are listed private commercial banks.Proponents of allowing new banks have made the following arguments: The Bank sector penetration in Bangladesh is a meager 15%compared to 32% in India, and 22% in Pakistan). The Bank sector has had an average annual deposit growth rate of19.31% in 2007-2011. This is high by any standard, considering inPakistan bank sector witnessed an average deposit growth rate of13.60% in 2007-2011 and Nigeria 15%, over 2009-2011. In frontiereconomies, this is partly an outcome of social mobility manifested byan increasing awareness of bank products. Secondly, it is also aresult of sales drives by banks and their increasing numbers ofbranches. In Bangladesh, the figures for interest rate spread (IRS) and netinterest margin (NIM) are quite high by global or regional standards.As of FY11, the average IRS and NIM for the Bank sector was4.95% and 4.10%, respectively.Figure 2: Country-wise banking sector penetration15%22%32%23%30%47%10%20%30%40%50%Bangladesh Pakistan India Vietnam Philippnes IndonesiaSource: Global Insight, Fitch and IFC1.0%2.0%3.0%4.0%5.0%6.0%7.0%8.0%2007 2008 2009 2010 2011EBangladesh Pakistan Sri Lanka VietnamFigure 3: Country-wise banking sector interest rate spreadSource: World Bank and BRAC EPL Research
Bank Sector Update: Nine New Banks forBangladesh The very low penetration, sustained YoY deposit growth of near20%, and very high IRS and NIM indicate that the Bangladesh banksector is not necessarily at stage when it cannot accommodatecompetition. Leading Bangladesh banks run very profitable business unrelated totheir spread income operations and the outlook for most of these arebright. These non-core operations include banking for the middle-market/SME; fee-based businesses such as remittance operations;and mobile banking businesses that are at an early stage andforecasted to drive growth long-term. A more conventional non-core bank business in the form ofcommissions-based trade financing is also expected to see betterdays once electricity and infrastructure bottlenecks are addressed. Itwould be difficult to set a timeline to when trade financing will pick upas all the external conditions are favorable: high manufacturing costsin China, slowdown in Europe and increasing demand for lower-endand middle-end RMG, low labor costs in Bangladesh, andconsiderably deep sector and product experience of BangladeshiRMG manufacturers. The variable in the form of infrastructurebottlenecks will have to be addressed. Going by McKinsey’s forecastof Bangladesh RMG manufacturers doubling output by 2015, at leastby 2014, even trade financing would pick up for the bank sector.However, 47 banks is a high count and the new banks will certainlycreate competition at a time when asset and deposit bases areconcentrating and liquidity outlook is a concern. The six banks that wereapproved on Sunday, April 8 will have to address the following macroand investment climate realities: A high inflationary environment is a severe detriment to bank sectorprofits, and even more so for conventional bank models that rely onspread-income business. New banks will be faced with the brunt ofhigh possibly double-digit inflation, if government borrowingforecasts are anything to go by. Government borrowing, quitesimply, crowds out private lending, raises lending rates and inflation.The energy demand-supply gap (around 2000MW/day) is increasingas a consequence of increasing urban migration andindustrialization. If the recent history of the availability of foreign anddonor funds is anything to go by, bank borrowing may be resilient, asmaybe inflation. Thus, new banks that wish to do core bankingbusiness in Bangladesh are likely to encounter very high cost offunds. New banks that wish to profit from trade commissions are likely tostruggle first because of slowing exports and curbed imports.Commission income from trade has a better longer-term prospecthowever, for those that can afford wait out the current externalsector challenges. New banks that wish to operate in the SME space may find it difficultinitially to first develop a large enough nation-wide network enablingdeposit growth necessary to justify the cost of loan collection andrecovery as well as the inevitably higher non-performing loan ratiosencountered by SME operations. Few nationwide NGOs have thesort of geographical penetration that SME-focused businesses
Bank Sector Update: Nine New Banks forBangladeshseek, and almost all the existing ones have existing partnershipswith banks. Thus barriers to entry for new banks in the SME spaceare high.However, the three Non-resident Bangladeshis banks that wereapproved prior to the recent six, present a more interesting proposition.Since they aim to focus on inward remittances, a growth sector forBangladesh, the Non-resident Bangladeshis banks are worth a closerlook: Non-resident Bangladeshis have easier access to Non-residentBangladeshis communities and associations, than do local privatebanks operating in Bangladesh. Increasingly, local private bankshave realized the importance of growing their representation ofsenior officers in migrant labor destinations. As local private banksdevelop best practices to grow their remittance operations hithertodominated by Islami Bank - Non-resident Bangladeshis banks canbe expected to have a competitive advantage by not having toprioritize servicing the citizens over the Diaspora. Moreover, there isempirical evidence to suggest that Non-resident Bangladeshis sharea significantly greater degree of empathy with another Non-residentBangladeshis. Despite the increasing competition in the remittance operations ofexisting banks, at least 40% of money sent back home byBangladeshis overseas travels through the hundi channel. This is aUSD 10 billion dollar plus market – the potential market for Non-resident Bangladeshis Banks.Our top picks are unaffected near-term (FY2012-FY2014):Islami Bank: The new Non-resident Bangladeshis banks will take atleast another 1 year to start operations. Moreover, remittancebusiness is largely dependent on customers’ confidence. As theentrepreneurs of Non-resident Bangladeshis banks are US and UK-based, they are expected to capture a very small portion ofremittance income from Middle-East region (~60% of inwardremittance come from ME). Currently, Islami Bank has over 120international correspondents, mostly in the Middle East, who assistin channeling inward remittances – this scale is of course not easilyimitable.Islami’s demand for fresh funds as borne out by 2011 has well-meton account of the demand inelasticity towards its deposit products,being the only fully shariah-compliant bank in Bangladesh, in anotherwise nascent Islamic Bank sector. The new banks are notexpected to have a direct impact on Islami’s deposit collectionFY2012-2014.Prime Bank: Of course when the new banks are fully operational,there will be greater competition for deposits, cost of funds of banksupwards. However, this is expected to take time and is contingentupon how well-run these new banks are, which is a question mark.Bangadeshi bank customers demonstrate a considerable degree ofbrand loyalty as is evidenced from the high spreads foreign banksenjoy ~9.3%. In 2011, one-year fixed deposit rates at well-
Bank Sector Update: Nine New Banks forBangladeshestablished banks like Prime reached a peak of 12.5% while severalNBFIs had offered up to 15%. Meanwhile, Prime’s deposits grew28% in 2011 YoY, which bears out the brand-consciousness ofBangladeshi bank customers.Prime’s remittance business is also expected to be largelyunaffected as 57.73% of total remittance originates from the MiddleEast and only 17.4% from the UK and the US.National Bank: National Bank, at present, remits the second-largestvolume among private commercial banks. Moreover, its partnershipswith Western Union Money, ASA (a leading NGO with 3,000 outletsin 64 districts of Bangladesh), and Social Islami Bank underscoresits potential for penetration in the rural market. National Bank is afirst generation bank (set up in 1983) and is still a leading playerwhich has ensured a brand loyalty and customer base. In fact, itspricing power is noteworthy from the 5%-plus IRS every year in 2006-2011. National Bank’s operations should not be affectedsignificantly in the near-term horizon by the new banks’ entry.BRAC Bank: BRAC Bank’s association with the SME loan productin Bangladesh has allowed it to thrive under challenging liquidityconditions. BRAC Bank is one of the three in our top picks list –along with Islami and Prime. BRAC Bank’s SME dominance takesadvantage of BRAC’s (the largest global NGO) penetration, withregard to loan disbursement and collection. BRAC Bank’s recentacquisition of Bikash, a mobile-banking service, will furtherconsolidate its SME dominance using telecommunicationtechnology. These economies of scale that BRAC Bank enjoys willbe very hard to emulate for new banks.In sum, it will be a challenge for the new banks to adapt to the ongoingclimate of liquidity constraint and the trick will be to grow by focusing onnon-interest income related operations, such as commission income,fees income, and perhaps investment income from portfolio investments.The challenges to growth have been elaborated earlier.Another objective of this report has been to highlight, challenges of newbanks notwithstanding, the growth opportunities in the Bangladesh Banksector. Banking products globally are increasingly commoditized and thecase for other Asian and particularly frontier economies is pretty similarwith regard to the growth prospects of non-core bank operations asopposed to spread-income based ones.In Bangladesh, the high mobile phone penetration and NGO penetrationoffer existing technologies and distribution networks for banks to employ.Given the low base of bank penetration, technology-based bankingservices that seek more inclusive business models, will fare well in theintermediate run, and sustainably so. Trade financing is also expected tobe a growth area if the manufacturing outlook that several leading globaladvisory firms forecast, materializes. Interest rate spreads shoulddecrease near-term amid increasing competition and liquidity tightening.However, spreads in Bangladesh are still higher than in many parts of theworld, underscoring the strength of the banking sector and investmentopportunities therein.
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