An Evaluation of Financial Stability and Soundness of the Banking Sector in Bangladesh

Abstract

This research is an endeavor to assess the soundness of financial health of banking
sector through IMF prescribed Core Financial Soundness Indicators Model (FSI)
for the selected banks in Bangladesh based on a panel data of 155 Bank-year
observations during the time horizon of 2015-2019. This study also assessed how
FSIs vary across different groups of banks (State-owned, Conventional Private
Commercial Banks (PCBs), Islamic Banks, Foreign Banks, 4th Generation Banks)
and impact the stability of banks in Bangladesh. Two separate analysis have
been conducted: Core FSI with ANOVA and bank stability with Panel Regression
Model. Bank Z Score value was used as a measure of Stability. Variables like
Capital Adequacy (CRAR), Asset Quality (NPL), Profitability (ROA & ROE) and
Liquidity (LCR & NSFR) were considered as measures of banking soundness.
The results show that soundness varies significantly among different groups of
banks. The condition of State-owned commercial banks is really perilous as they
are burdened with significantly high amount of NPL and lower amount of profit.
Only Foreign banks showed better financial soundness in terms of all the chosen
FSIs. The results of Panel Fixed Effect Model depict that profitability has strong
positive impact on banking stability in Bangladesh. Non-performing loans
and liquidity have negative impact on stability. The regression findings also
reveal that capital adequacy impacts stability negatively. This negative relation
demands a thorough review of the existing capital adequacy requirements of the
country’s banking sector. These research findings will provide the policy-makers
as well as the regulatory authorities with significant policy implications and
also help them conduct an in-depth macro-prudential analysis towards a stable
financial system. However, these findings require to be interpreted cautiously
keeping in mind that these selected FSIs are only some of many other tools such
as early warning systems, stress testing and so on.