Yunus Government Overhauls Bangladesh’s Banking System Amid Crisis

The interim government of Bangladesh, led by economist Muhammad Yunus, is undertaking significant reforms to stabilize the nation’s banking sector, which was on the brink of collapse following the end of Sheikh Hasina’s long-standing administration. As of March 2024, non-performing loans had reached over 1.7 trillion taka, equivalent to approximately $15.5 billion, representing nearly 11 percent of the total outstanding credit of about $140 billion. Analysts suggest that the actual figures could be much higher when factoring in rescheduled and evergreen loans.

The banking crisis has its roots in years of politically motivated lending practices, which resulted in significant governance failures and widespread regulatory indulgence. Many banks were effectively insolvent and continued to operate only due to substantial liquidity support from the Bangladesh Bank, amounting to billions of dollars, leading to a loss of depositor confidence. Some institutions, especially within the Islamic banking sector, exhibited alarmingly low capital adequacy ratios, failing to meet even the minimum standards set by Basel III.

In response, Yunus’s government quickly implemented reforms aimed at restoring the integrity and functionality of the banking system. The administration prioritized the reestablishment of the central bank’s supervisory authority, reconstituted boards of troubled banks, and made long-overdue decisions to address the crisis. Unlike previous attempts at reform, which offered short-term fixes, the current approach recognized the need for substantial changes in the banking landscape.

Significant Banking Mergers Initiated

Among the most notable actions was the decision to merge five struggling Islamic banks into a single, consolidated institution. This entity is set to manage deposits exceeding 1.1 trillion taka (around $10 billion) and will encompass combined assets of more than $13 billion. Previous administrations had avoided such mergers due to fears of political backlash and legal complications. The new framework established by the Yunus government enables the central bank to prioritize systemic stability over shareholder interests.

Under this reform, shareholders of the merged banks absorbed significant losses, and their balance sheets underwent restructuring under the oversight of the central bank. The state has committed substantial fiscal support, estimated between $1.8 billion to $2.2 billion, to protect depositors and restore stability. The reopening of withdrawal capabilities after months of restrictions has marked a critical psychological shift, bolstering depositor confidence and mitigating the risk of widespread financial contagion.

The rationale behind the consolidation is straightforward. With more than 60 commercial banks operating in a $460 billion economy, the banking sector had become overcrowded and excessively politicized, leading to weak governance. Mergers are expected to create economies of scale, simplify regulatory oversight, and reduce opportunities for regulatory arbitrage.

Yunus’s administration has also focused on enhancing regulations surrounding related-party lending and enforcing stricter loan classification standards. Additionally, a gradual move away from interest-rate caps has begun to address long-standing distortions in risk pricing.

A Shift in Political Context

The backdrop for these reforms has changed markedly with the fall of Hasina’s government, which had provided cover for influential borrowers responsible for substantial amounts of bad loans. The previous administration blurred the lines between political power and financial privilege, creating a precarious situation for the banking system. Although the interim government lacks an electoral mandate, it has gained legitimacy through its decisive actions in the wake of the political upheaval.

Despite these reforms, challenges remain. Merging banks is a complex process, particularly in a context where asset quality is disputed and recovery values are uncertain. Analysts project that cleaning up the legacy of bad loans could take five to seven years, potentially requiring several billion dollars in additional capital support. The sustainability of these reforms will largely depend on whether the next elected government remains committed to avoiding politically expedient banking practices.

The current shift represents a significant departure from the past. Under Hasina’s administration, financial stability was often achieved through regulatory suppression rather than genuine reform, imposing hidden costs on depositors and smaller borrowers while undermining the credibility of the financial system.

Yunus’s approach, while more transparent and disruptive in the short term, offers a credible path forward. Beyond banking, a robust financial system is vital for investment and growth, especially as Bangladesh faces external pressures from global monetary tightening and export uncertainties.

While the road ahead is fraught with risks, Yunus’s government has moved away from treating the banking sector as a political instrument. Instead, it emphasizes the necessity of a functional banking system that can either operate effectively or undergo necessary restructuring. For an interim government with limited time and no electoral base, this achievement could become a vital legacy of Bangladesh’s transition following the political uprising, demonstrating that meaningful structural change is possible even in times of uncertainty.