Creating a more efficient financial system : challenges for Bangladesh

Bangladesh has embarked on a path to reform its financial system, most prominently by privatising its government-owned banks, the Nationalised Commercial Banks (NCBs). This policy research working paper argues that if the expansion of the financial system is to be sustainable, a more substantial change in the role of government is required.

The paper analyses recent research and undertake an international comparison of the relationship between finance, investment and growth in Bangladesh and other low-income countries. The authors examine the progress made by Bangladesh in reforming its economy, and discuss the role of the Bangladeshi government in relation to three prevalent views on the necessary role of government in the finance sector: the laissez-faire view, the market-failure view and the market-enabling view.

The paper concludes that:

• Bangladesh would have reduced poverty further if it had had a higher level of private credit
• a nationalised financial system is not effective at channeling savings into investments and economic growth
• though Bangladesh has made great progress in creating macroeconomic stability, it still has a long way to go in building the contractual and informational framework in spite of some promising reforms
• bank supervision in Bangladesh is heavy-handed compared to other countries, and corruption in licensing and lending is limiting investment and growth

Finally, the authors offer a reform agenda for Bangladesh. While warning against the proven dangers of a poorly implemented privatisation programme, they argue that the government should move from its role as an operator and arbiter in the financial system to a facilitator role. This implies:

• privatisation of government-owned banks
• de-politicisation of the licensing process
• a market-based bank failure resolution framework that focuses on intermediation and not on the rescue of individual institutions
• greater government reliance on market participants to monitor and discipline banks, instead of micro-managing financial institutions

The paper argues that this redefinition of government’s role should not be limited to the banking system, but applies to other segments of the financial system, such as capital markets and the micro-finance sector, and should be seen as an essential element in the governance reform agenda and in the movement from a relationship-based economy to a market and arms-length economy.