Last Monday, at the Bangladesh Bank headquarters, the managing directors of Exim Bank and Padma Bank signed an agreement to begin what can be termed as the first voluntary bank merger in Bangladesh's history.

Padma Bank, which had been struggling financially despite a government bailout of 1,700 crore taka, will be absorbed by Exim Bank, one of the nation's leading Islamic banks. Following the merger, the combined entity will operate solely under the Exim Bank banner, phasing out the Padma Bank name.

Praising the merger, Exim Bank Chairman Nazrul Islam Majumder, the longstanding leader of the Bangladesh Association of Banks (BAB), told reporters that this decision is "historic for the country's improvement."  Bangladesh Bank Governor Abdur Rouf Talukder, who witnessed the relatively low-key ceremony, appeared to share Majumder's optimism.

The Exim Bank-Padma Bank merger announcement came just one week after Governor Talukder urged bank owners to consider consolidation, either through voluntary mergers or potential government-directed actions. The Governor also offered incentives to encourage voluntary mergers among Bangladeshi banks.

The central bank has already made plans to go for forced merger of at least 10 banks by January next year as part of its road map to reduce default loans and ensure corporate governance in the banking sector. Talukder shared the plan with BAB at a meeting early this month.

Why the mergers?

The central bank’s intervention in merging mainly weak banks with strong ones comes on the heel of a prolonged blue period for the whole banking sector which has been facing a significant challenge with rising non-performing loans.

In 2023 alone, defaults surged by 25,000 crore taka, pushing the total default figure to a staggering 1.45 lakh crore taka by December. This represents a concerning 9% of the entire loan portfolio, which stood at 16.17 lakh crore taka.

An analysis of defaults from June 2023 reveals a worrying trend: just 11 banks were responsible for a whopping 93% (Tk. 24,419 crore) of the defaulted loans. This highlights the concentration of risk within the system, said experts concerned.

Further compounding the issue is the undercapitalization of many banks. Data from Bangladesh Bank shows a capital shortfall of Tk. 37,506 crore for 14 banks by September 2023. This lack of adequate capital buffers makes them more vulnerable to financial shocks.

The current crowded market with 61 commercial banks and 34 non-bank financial institutions doesn't help either. Notably, nine new banks—including Padma Bank which was established as Farmer’s Bank— were licensed in 2012, potentially due to political considerations, and many of them continue to struggle in this oversaturated landscape.

“Padma Bank's history is a cautionary tale of financial struggles,” Mizanur Rahman, a former banker told Bangla Outlook, “It’s a classic example of how not to run a bank.”

Established in 2013 as Farmers Bank, it faced imminent collapse due to widespread irregularities in lending practices. To prevent a full-blown crisis, four state-owned banks (Sonali, Janata, Agrani, and Rupali) along with the Investment Corporation of Bangladesh offered a bailout package worth Tk. 715 crore in 2018.

Despite this initial injection of public funds, Padma Bank's situation remained precarious. The state-owned banks further invested around Tk. 1,000 crore through subordinate bonds and fixed deposits.

However, these efforts were insufficient to address the core issue – a high volume of non-performing loans (NPLs). By the end of 2023, Padma Bank held Tk. 5,740 crore in outstanding loans, a staggering Tk. 3,550 crore of which were classified as NPLs. This translates to a concerning default rate of nearly 47% as of June 2023, signifying the bank's limited capacity to repay depositors.

Padma Bank's financial woes extended beyond NPLs. The bank also faced a capital shortfall of Tk. 607 crore by September 2023. Notably, depositors entrusted the bank with over Tk. 6,500 crore by June 2023. However, the bank's liabilities significantly exceeded its assets, with a primary data gap of Tk. 5,000 crore.

“I think this this merger of a weak bank with a strong one is nothing but a quick “band-aid” solution, especially in the Bangladeshi context” Rahman said, “Unless the core issues of the banking sector crisis are not addressed, then it will not solve the persisting problems in the long run.”

Will mergers solve the core problem?

Dr Md Main Uddin, Professor of the department of Banking and Insurance of Dhaka University told Bangla Outlook that bank mergers are often seen as advantageous for both the acquiring bank (bidder) and the acquired bank (target).

“This can be gauged by how stock prices react for publicly traded banks involved in mergers. Studies suggest that the target bank typically enjoys short-term gains, while the bidder benefits in the long run,” he said.

However, Dr Uddin said, a significant challenge lies in the accuracy and reliability of the data used to evaluate the target bank. “There's a major discrepancy between the non-performing loan (NPL) figures reported by individual banks in Bangladesh and those identified by the central bank,” he said adding that this lack of reliable data makes it difficult for the bidder to accurately evaluate the target bank, potentially leading to flawed merger decisions.

Meanwhile, concerns are already brewing among owners, directors and officials of healthy banks regarding the prospect of forced mergers with struggling institutions. They fear the Exim Bank-Padma Bank merger sets a precedent for strong banks being burdened with the problems of weak ones.

The recently amended Bank Company Act (2023) empowers Bangladesh Bank to take decisive action against banks that prioritize poorly. The central bank can now initiate forced mergers if a bank's board and management engage in activities that jeopardize depositors' interests.

Furthermore, the Act grants Bangladesh Bank the authority to implement consolidation or restructuring measures for any bank that demonstrably fails to execute a satisfactory recovery plan. These measures aim to strengthen the overall health of the banking sector.

Monzurur Rahman, chairman of Pubali Bank believes merging a weak bank with a strong one doesn't make sense. “Pubali Bank, for example, is performing well compared to other private banks. We shouldn't be forced to absorb a struggling institution.”

Professor Uddin said, for well-performing banks hesitant about mergers due to potential performance declines, the Bangladesh Bank might explore persuasion with incentives rather than resorting to forceful measures. “However, for persistently weak banks, allowing a controlled wind-down process could be a viable option to minimize further losses,” he added.