The overview of Financial System and Microfinance in Bangladesh

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  • RegulationandSupervisionofMFIsinBangladesh1

    By

    Dr.Md.KabirAhmedBangladeshBank

    ThePaperPresentedintheSAARCFINANCESeminaron

    "RegulationandSupervisionofMicrofinanceInstitutions(MFIs)inSAARCRegion

    OrganizedbyNepalRastraBank

    Kathmandu,2022March,2013

    1OpinionsexpressedinthepaperareofauthorsownanddonotnecessarilyreflectneitherthepoliciesandstandsofBangladeshBanknorMicrofinanceRegulatoryAuthorityoranyotheragency inBangladesh. Iamgrateful toDr.Md.Aktaruzzaman,EconomicAdvisor,BangladeshBankforhisvaluablesuggestionsandcommentsintheearlierversionofthepaper.

  • 1

    1.0IntroductionPovertyandemploymentcreationare theoverarchinggoalsofall theSAARCnations.Sharingour

    knowledgeandexperienceinthisendeavourcangraduallybuildaSouthAsianCommonKnowledge

    Pool thatmayguide the futureof this region fromapoverty zone toaprosperityone.However,

    characteristicsofBangladesharethatitisoneofthemostpopulouscountrieshavingpopulationof

    152.5millionswithin a small territoryof 147600 square kilometres. Life expectancyofpeople at

    birthis69yearsand71percentofthemliveinruralareas.Despitebeingoneofthemostpopulous

    and ruralbased economywith frequent natural attacks, the country has achieved commendable

    success inthe last4decadesbyreducingpovertyfrom59percent in1984to31.5percent in2010

    (BBS,2011).ThecountrymaintainedsixpercentrealGDPgrowthforthe lastdecade.Povertyalso

    declinedmore than2percentagepointsince2005.Given thispaceofdevelopmentand following

    thesimplealgebra,thestoryaheadforBangladeshisthatitcanbeapovertyfreecountryby2030.It

    maysurprisemanyofusthatwithmoderatelevelGDPgrowthand65percentlandlesspopulation,

    how the country achieved this covetous success while the development partners were always

    assumingitasahugechallengeforaresourcepoorcountry.

    Fortunately,while policymakers in Bangladesh delinked financial network of rural economy by

    reducing lossmaking rural bank branches as per recommendations of Financial Sector Reform

    Program in 1990, the countrywitnessed a demand driven propoor growthmodel that evolved

    withintheruralsectorthroughmassiveexpansionofNGOMFIs followingthesuccessofGrameen

    Banksmicrocreditactivities. Aftera longexperimentwith continuous success,our learning from

    themisthatwhiletheirsocialmissionenablesthemtoaddresspoverty,alargenumberofgrowth

    promoting high yielding small projects financed by them significantly contribute to employment

    creationandsustainablemoderatelevelGDPgrowthamidaperiodofglobalfinancialandeconomic

    crises. Allure by their contribution for a social cause, establishment of a separate body for the

    regulationandsupervisionof the industry iswelldebatedamong thepolicymakers,academicians

    and practitioners since late 1990s. However, considering several factors such as enormous

    involvementofMFIs in savingsmobilization, furthering their activities in socialbusiness,building

    confidence among the financiers for their continuous support; Government in Bangladesh has

    establishedaseparateregulatoryandsupervisorybodyi.e.MicrocreditRegulatoryAuthority(MRA)

    in 2006. The Authority also promulgated some prudential rules in 2010 for development of the

    industryona sustainablebasisbybringingmore transparency, reducingdistortionand creatinga

    level playing field for all the market players. Nevertheless, there are still some problems and

    challengesfacedbytheindustryaswellasthisnewbornAuthorityinimplementingregulationsand

  • 2

    supervisionsofNGOMFIsalongwithotherprovidersofmicrofinanceservices.Thispaperhasbriefly

    discussed these issueswhileproposingsomemeasures tobe takentoaddress them.Thepaper is

    organizedasfollows.Thenextsectiondescribesdevelopmentofmicrofinanceindustryemphasizing

    onthereasonsthathelpedtogrowNGOMFIs inruraleconomyofBangladesh.Section3narrates

    themeasures that are initiated to improve the legal and regulatory architecture of the industry

    includingtheimpactofnewMicrocreditRegulationAct2006.Section4highlightsontheregulatory

    and supervisory problems and challenges faced by both the microfinance markets and the

    regulatoryauthorities. Insection5,somepossiblemeasuresareproposedtoaddresstheongoing

    challengesfacedbyallthemarketparticipantsincludingtheregulators.Section6concludes.

    2.0MicrofinancedevelopmentinBangladesh

    StageI(19711982):Traditionalinstitutions

    After independence in 1971, state owned rural banks and cooperative societies were primarily

    engaged in rural financing activities wheremicrocredit was embedded in their services. At the

    beginning,asapartofpreindependencepoliticalcommitment foreconomicemancipationof the

    ruralpoor,thegovernmentinBangladeshwantedtoincreasebankingfacilitiestotheruralareasof

    thecountry(BB,1974).However,itwasdifficulttomaterializethisobjective,astherewasonlyone

    governmentownedagriculturalbank,whichhadalimitednumberofbranches(only75branchesin

    1972) in the entire country. The other governmentowned six commercial banks namely Sonali,

    Janata,Agrani,Rupali,PubaliandUttararemainedabsenttill1977inagriculturalfinancinginrural

    economy,althoughtheyhadlimitedexposureinnonagriculturalcreditactivities.Themaintargetof

    thesecommercialbankswasdepositcollectionforsubsequent investment inurbanareas.In1974,

    theeconomicadversitymainlydue todevastating floodprompted thegovernmentsattention to

    revive agroeconomy. Another important factor that drew policy makers attention is that as

    agriculture contributed considerably todomesticoutput throughout the1970s, thegovernments

    desiretoincreasenationaloutputalsoentailedemphasizeonthissector.Forexample,inthefiscal

    year1977agriculturealoneaccountedfor54percentofaggregateGDP(BB,1978).Consideringall

    thesefactors,thegovernmentinitiatedaSpecializedAgriculturalCreditProgram(SACP)inFebruary

    1977. Themain purpose of this programwas to enhance the flow of institutional credit to the

    agriculturesector.Anotherpurposewas to reach institutionalcredit facilities to themarginaland

    small farmers.Both theCentralBank and the government administered this credit program and

    implemented it throughstateownedcommercialbanks,aswellasagriculturalbanks.Sincestate

    ownedbankswerenotinvolvedinagriculturallendinguntil1977,andtheonlyagriculturalbankhad

  • verylimitedbranches,thisnewinitiativesrequiredallofthemtoexpandbankbranchesinunbanked

    areas of the local economy. Consequently, the rural financial infrastructure increased rapidly in

    1977, although the growth of bank branch continued at a very slow pace until late 1980s and

    remainedstagnantsincethebeginningof1990s.

    Chart1:Numberofnewruralbankbranches

    0

    100

    200

    300

    400

    500

    600

    700

    800

    900

    1977 1980 1983 1986 1989 1992 1995 1998 2001 2004

    No. o

    f new

    rural

    bank

    bran

    ches

    Source:Annualreports(variousissues),BangladeshBank

    Apart from rural banks, two types of cooperatives such as traditional and nontraditionalwere

    engaged inmicrocredit activities. The traditional cooperatives,which continued since theBritish

    Raj,weremostly nonagriculture in character. Theywere organized and supervised by an apex

    institution,namelyBangladesh SamabayaBank (BSB).The traditional cooperatives are supervised

    and partly financed by Bangladesh Samabaya (Cooperative) Bank. The policy of these traditional

    cooperativeswastoestablishonecentralcooperativebankineachsubdivision(presentdistrict)as

    secondarylevelandMultipurposeCooperativeSocietiesineachunionasprimarylevel.Thepurpose

    oftheprimarysocietieswastoprovidecredittomembersengagedinactivitiessuchasagriculture,

    afforestation,fishingandcottageindustries.

    The nontraditional cooperatives were established based on the Comilla Model, which was

    developedand triedonanexperimentalbasis in the1960s.Twomajorcomponentsof themodel

    weretheestablishmentof (i)primarycooperativesatthevillage level,generallyknownasKrishak

    Samabaya Samity (KSS),whichwas organized by three categories of people: landless labourers,

    marginalandwealthyfarmersand(ii)allKSSswithinasubdistrictwerefederatedintoTCCA2/UCCA.

    Themajor responsibility of TCCA/UCCAwas to provide input support, training, credit and other

    services to theKSS. After its initialsuccessduring thepreliberationperiod,asapartofpoverty

    orientedruraldevelopmentstrategythegovernmentwantedtoimplementtheideathroughoutthe

    3

    2 TCCA/UCCA refers to Thana or Upazila Central Cooperative Associations. Thana is an administrative unit which was converted into upazila in 1983.

  • 4

    ruraleconomyaiming todevelopanequitablesocietyby includingallcategoriesofhouseholds in

    rural development activities. Adoption of high yielding varieties, i.e., seedfertilizerirrigation

    technologywasassumedtobeequallybeneficialtosmallholdersaswellaslargefarmers.Thetwo

    tiercooperativesystemwasconsideredasoneoftheeasiestwaysofdiffusingmoderninputs,credit

    and knowledge to the small farmers without bringing any fundamental change to the private

    ownershipofland.

    In parallel with government efforts, a number of nongovernmental organizations (NGOs) were

    working in the 1970s for rural development and poverty alleviation.However, creditwas only a

    small part of their overall programme. Theymainly perceived poverty as a consequence of the

    poors systematic disorganised relationship with the economic, social and political system.

    Awareness creation and group solidarity had been considered as a longterm solution to escape

    poverty.

    StageII(19821989):Birthofmodernmicrofinanceinstitutions

    During the1980s, rural financialmarket (RFM) inBangladeshexperienced three typesofnotable

    changes. These are (i) change in legal status and reorientation of organizational objective, (ii)

    entranceofnewtypeofbankand(iii)changeinbankownershipstructure.Thefirstchangeoccurred

    by transforming the IRDP into the BRDB (Bangladesh Rural Development Board) in 1982. The

    backgroundofthistransformationisthatalthoughtheprogrammesofIRDPwasrapidlyexpandingin

    most of the subdistricts, their role as a reliable vehicle for rural poverty alleviation through

    equitableparticipationindevelopmentwerequestionedduetothegreaterinfluencebythewealthy

    farmersatKSSlevel(Ali,1990).Asaresponsetothesecriticisms,aneffortwasmadetoreformthis

    programme.IRDPwasreconstitutedin1982asaparastatalbodyandrenamedasBRDB,3mandating

    itsroleforincomeandemploymentgenerationfortheruralpoor.

    WhilethefocusofIRDP/BRDBandBKBwasagriculture,duringthesametimealargesectionofthe

    ruralpopulation inBangladeshsuchasday labourers,traders, fishermenandwomenearnedtheir

    livelihoodfromnonagriculturesector.Theywerevirtuallylandlessandstruggledtomeettheirbasic

    humanneeds.As landwas theprimarycollateral ingettingaccess tocredit from localbanks, this

    sectionofthepopulationwasoutsideofformalbankingfacilitiesforaconsiderableperiodandwas

    trappedintoaviciouscycleofpoverty.Inordertoservethissectionofsociety,amaterialisticschool

    3 UndertheBangladeshRuralDevelopmentBoardOrdinance,1982.

  • 5

    ofthoughtemergedin1983throughtheestablishmentoftheGrameenBank4arguingthatthepoor

    needmaterialisticassistancetoimprovetheireconomicsituation.ThenewnessofGrameenBankis

    that the bank is legally mandated to provide credit facilities and other services to landless

    households in rural areas. Another change occurred when the government, as a generalmove

    towards private sector participation in economic activities, privatised two state owned banks,

    namelyPubaliandUttara, in1985.Thisdecision leftruralbranchesoftheotherfourgovernment

    ownedcommercialbanksand lonegovernmentownedagriculturalbankasdirectvehiclesforrural

    developmentthroughcredit intervention. In1986,the loneagriculturalbank,BKB,was legallysplit

    intoBKBandRAKUB(RajshahiKrishiUnnayanBank)5.The latterstartedworking inMarch1987by

    takingoverthebranchesandofficesalongwithassetsandliabilitiesofBangladeshKrishiBankwithin

    theRajshahidivision6.Thenewbanksobjective remains the samewithanexceptionof regional

    focus.Theperiodof1980salsoexperiencedthebirthofanumberofprivatebanks,knownasfirst

    generationprivatebanks.However,exceptIslamiBank,noneofthemopenedanybranchinarural

    area.Thelatterbankfirstestablishedtheprivatesectorruralbranchin1988.Theabovediscussion

    suggeststhatexceptestablishmentofGrameenBank,therewasnomajorchange inorganizational

    makeupof the rural financialmarket in the 1980s.As argued earlier, although theNGOs in the

    1980swereinclosecontactwiththepoor,theymostlyfollowedtheconscientizationapproachasa

    longtermsolutiontopoverty.However,successofGrameenBankinfluenceddevelopmentthought

    ofNGOsandanumberofbegantoreplicateGrameenBankModelonanexperimentalbasis.

    StageIII(19901996):GrowthphaseofMFIs

    Marketbasedpolicyreformandclosureofruralbankbranchnetwork

    In 1990, the Central Bank undertook a financial sector reform program under the guidance of

    development partners. This reform program deviated from the social objectives of rural bank

    branchesandemphasizedtheircommercialviability.Theysuggestedforclosureandmergersofloss

    makingbranches.Thisdecisioninfluencedstateownedbanksbranchexpansion,causedmergerand

    closuresofsomeof the lossmakingbankbranchesandsloweddown theexpansionof ruralbank

    branches inruraleconomythroughoutthe1990s.Branchexpansion inthe latterpartofthe1990s

    wasalmoststagnant.RatherruralbranchesoftheNCBs(seeChart2)marginallydeclinedduringthe

    periodof1991to2004.

    4 It was established under a special ordinance , namely Grameen Bank Ordinance 1983. 5 Presidents Ordinance No. 58, 1986 6 During that period, Bangladesh had four divisions. Other divisions were Dhaka, Chittagong and Khulna.

  • Chart2:Totalnumberofruralbankbranchesbytypesofbanks

    195020002050210021502200225023002350240024502500

    1983198419851986198719881989199019911992199319941995199619971998199920002001200220032004

    No.

    of r

    ural

    ban

    k br

    anch

    es

    0

    200

    400

    600

    800

    1000

    1200

    1400

    NCBs (left scale) Specialised banks (right scale)

    Source:BangladeshBank(2008)

    Inthesamefigure,wecanobserveamildgrowthofthenumberofagriculturalbankbranchessince

    2002while a declining trend in bank branches forNCBs can be found during the corresponding

    period.ThesetrendsemergedasagriculturalbankstookoversomeoftheruralbranchesofNCBs.

    Asmentionedearlier,prioritysectorlendingpolicywascompromisedunderfinancialsectorreform

    program forenablingacompetitive financialmarketenvironment throughanumberofmeasures

    including liberalizationof interestpolicy. As a response, rural creditdeposit ratio aswell asper

    capita ruralcreditbegan to shrinkhampering thedevelopmentactivitiesof ruraleconomywhere

    mostofthepoorliveandearntheirlivelihood(seeChart3and4).

    Chart3:Ruralcreditdepositratio

    0

    20

    40

    60

    80

    100

    120

    140

    160

    180

    Apr

    .-Jun

    .'77

    Jul-S

    ept.'

    78

    Oct

    .-Dec

    .'79

    Jan.

    -Mar

    .'81

    Apr

    .-Jun

    .'82

    Jul-S

    ept.'

    83

    Oct

    .-Dec

    .'84

    Jan.

    -Mar

    .86

    Apr

    .-Jun

    .'87

    Oct

    .-Dec

    .'88

    Apr

    .-Jun

    .'91

    Oct

    .-Dec

    .'92

    Jan.

    -Mar

    .'94

    Apr

    .-Jun

    .'95

    Jul-S

    ept.'

    96

    Oct

    .-Dec

    .'97

    Jan.

    -Mar

    .'99

    Apr

    .-Jun

    .'00

    Jul-S

    ept.'

    01

    Oct

    -Dec

    '02

    Jan.

    -Mar

    .'04

    Apr

    .-Jun

    .'05

    Jul-S

    ept.'

    06

    Rur

    al c

    redi

    t-de

    posi

    t rat

    io

    Source:BangladeshBank(2008)

    6

  • Chart4:Percapitaruraldepositandcredit

    0

    500

    1000

    1500

    2000

    2500

    1980 1990 2000 2005

    Ban

    glad

    esh

    Taka

    Per capita rural deposit Per capita rural credit

    Source:BangladeshBank(2008)

    Whenmarketbased neoclassical ideawas atwork for rural banks, this period coincidedwith a

    major shift in theparadigmofdevelopment th...

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