How Bangladesh Can Boost its Economy Through Capital Market and Bank Reform

Bangladesh’s economic progress is at risk due to a weak banking sector and the absence of a functioning capital market.

The banking sector is the weakest link in Bangladesh’s economy. Despite the strength and competitiveness of the overall economy, banks have long posed serious risks. 

A review of bank asset quality is underway and expected to expose the extent of damage in several stressed banks. It may also reveal the economic burden ahead.

While reforms are ongoing, they focus mainly on the banking sector, with inadequate attention to capital markets. In a balanced financial system, banks, bond markets, and stock markets play complementary roles.

The poor state of the banking sector is tied to the absence of a functional capital market—critical for long-term financial stability. Capital markets fund long-term assets, while banks, with short-maturity deposits, should finance working capital and daily transactions, which is essential for the sector’s stability. 

Banks are currently making long-term loans for fixed assets. In doing so, they have supported industrial development and mortgage lending—but at great cost. This structural mismatch threatens growth and economic stability.

A functional capital market would channel long-term funds from life insurers and other sources into productive investments. Yet Bangladesh’s life insurance sector is poorly governed and small relative to the overall economy. 

About a quarter of its funds go into short-term deposits and real estate—an unacceptable waste of long-term capital. These investments inflate land prices, harming industrial and infrastructure development.

Lacking a bond market, insurers have few long-term investment options. Bangladesh seeks foreign direct investment, but squanders its own billion-dollar life insurance funds due to a missing bond market. This contradiction undermines the economy.

Countries like Indonesia, Malaysia, and India invest a large share of life insurance funds in long-term bonds, financing infrastructure, housing, and industry. This is possible because they have functioning corporate bond markets—unlike Bangladesh.

Bangladesh is a top country for receiving inward remittances, one-fourth of which goes to the real estate sector challenging industrialization efforts. Inward remittances can have a positive impact on long-term investments if there are functional bond and equity markets. 

A transparent capital market is also a prerequisite to introducing much-needed derivative instruments for mitigating risks for businesses and the economy.

In Bangladesh, banks issue corporate bonds mainly to raise Tier-II capital through reciprocal deals with other banks, offering little benefit to the bond market or banking stability.

Affordable housing is a national priority. A healthy mortgage finance market can turn housing expenses into investment, boosting household wealth. In Bangladesh, housing costs consume large portions of household income. With a mortgage bond market, these costs could become wealth-building investments.

A sustainable housing finance sector requires a national mortgage warehouse to refinance loans from banks and financial institutions. This warehouse could also issue mortgage-backed securities through securitization—a tool that reduces asset-liability mismatches and improves liquidity.

Beyond housing, securitization could attract domestic and foreign capital to priority sectors like infrastructure and industry.

Capital market reforms should include drafting securitization rules and establishing a mortgage warehouse—steps already taken in Malaysia, Indonesia, and India.

Development finance institutions can help by drafting rules, supporting new institutions, taking equity stakes, improving governance, and transferring technology.

Global capital is available. Bangladesh needs investment vehicles and instruments that match the diverse appetites of investors in its private sector-led economy.

Source: blogs.adb.org