Whenever discussions turn to Bangladesh’s perpetually underdeveloped capital market, observers point to poor corporate governance and lax regulatory enforcement. Governance in our financial sector is undeniably weak, and elevating it is urgent. Yet, treating governance failure in isolation misdiagnoses the problem. Governance standards do not materialise out of thin air; they reflect the incentives embedded within the financial architecture. Without decisive structural reform, appropriate governance cannot be achieved or sustained.
The root bottleneck holding back our bond and equity markets is structural: our financial ecosystem makes commercial bank credit artificially cheap and opaque. Commercial banks often operate on paper-thin real capital. Regulators allow them to fund multi-year industrial assets using short-term, low-cost deposits. This creates an overwhelming incentive for corporate borrowers to shun public markets. Consequently, long-term industrial risks sit concentrated inside the banking sector, generating recurring cycles of unpaid loans and acute liquidity crunches.
The asymmetry: Why issuers avoid public markets
In a balanced economy, fixed capital investments like factories and infrastructure rely on long-term debt or equity backed by institutional investors. In Bangladesh, corporate borrowers bypass public markets in favor of bilateral bank loans due to deep structural asymmetries.
Issuing a corporate bond requires audited records, credit rating surveillance, detailed prospectuses, and continuous public accountability.
Bilateral bank credit, by contrast, is negotiated privately with flexible covenants and minimal disclosure. Furthermore, commercial banks have historically extended long-term project loans without pricing in term or liquidity risks. They rely on cheap retail deposits, policy refinance lines, and implicit expectations of regulatory forbearance. Corporates also rarely commit to rigid bond repayment schedules. Instead, they fund long-gestation assets by rolling over short-term working capital facilities indefinitely, converting short-term facilities into de facto perpetual debt with zero market discipline.
The capital illusion: Profitability over solvency
A central driver of this fragile dynamic is how banks are evaluated by regulators, boards, and the market. Public discourse routinely celebrates accounting profitability and balance-sheet expansion while ignoring underlying capital metrics.
Banks frequently report robust operating profits and announce dividends based on accrued interest income from rescheduled and repeatedly rolled-over loans—cash flows that have never actually entered their vaults. Thinly capitalised banks carry immense duration and credit risks without setting aside realistic risk-weighted capital buffers under Basel III.
Evaluating a bank primarily on loan growth and paper profits rather than real Common Equity Tier 1 (CET1) capital creates a severe moral hazard. It encourages lenders to extend high-risk, long-term credit on fragile equity to maximise short-term accounting returns. At the same time, it conceals true solvency problems until a macroeconomic shock forces a sudden, costly recognition of bad assets. A financial system where banks project paper health on eroded capital bases destroys any incentive for long-term risks to migrate to the capital market.
Synthetic project finance: Arbitrage beyond borders
This structural distortion extends beyond domestic currency loans into cross-border credit. During the era of near-zero global interest rates and a tightly managed currency peg, banks and corporates turned routine trade tools, such as Usance Payable at Sight (UPAS) deferred letters of credit, into synthetic project finance.
While elevating governance standards across both banks and corporates is non-negotiable, governance will not thrive in a fundamentally broken market structure
Borrowers used these low-interest, short-term foreign currency facilities to import capital machinery for non-export projects that earned revenue exclusively in BDT. When global interest rates climbed and the currency depreciated, the cost of servicing this unhedged foreign debt surged by 30 to 40 percent. Importers could not settle these ballooning foreign obligations. Banks then converted unpaid liabilities into overdue local currency loans on their own balance sheets, evolving from an easy regulatory arbitrage into a systemic shock that strained national reserves and drained interbank liquidity.
Why governance requires structural counterparties
The traditional response to financial distress has been purely administrative. The central bank issues circulars capping lending rates, ordering restructuring mandates, and offering forbearance packages. While governance standards are lacking and must be upgraded, administrative circulars alone cannot manufacture good governance.
Governance is an equilibrium outcome of stakeholder consensus. In an ecosystem dominated by a tight nexus of large borrowers and closely held banks, incentives naturally align around continuous loan rollovers and regulatory forbearance. Without independent market counterparties who possess an economic stake in transparency, administrative mandates merely push risk into creative accounting maneuvers. Robust governance takes root only when borrowers answer to diverse capital market participants, such as pension trustees, institutional bondholders, and independent asset managers, who possess both the legal standing and the financial incentive to enforce debt covenants.
Fixing the financial ecosystem
To break this structural trap, policymakers must align banking regulations with capital market development.
Regulators must enforce strict capital realism by mandating significantly higher risk-weighted capital charges on long-duration corporate exposures held on bank balance sheets. Authorities should end the practice of treating accounting profit as a proxy for financial health, enforcing verified CET1 capital adequacy before allowing dividend payouts or balance-sheet expansion.
Simultaneously, policy must eliminate synthetic long-term bank credit by enforcing strict single-borrower caps and prohibiting repeated rollovers of short-term credit for capital equipment. To build market depth, authorities need to establish clear statutory mandates for provident funds and insurance companies to deploy a designated portion of their assets into rated corporate bonds. Developing a liquid secondary market for government securities across various maturities will then provide the transparent, risk-free benchmark yield curve necessary to price private corporate debt accurately.
Moving forward
Bangladesh cannot fund multi-decade industrialisation on the back of 3-month retail deposits and thinly capitalised banks. While elevating governance standards across both banks and corporates is non-negotiable, governance will not thrive in a fundamentally broken market structure.
Until policy restores capital discipline to commercial banking and dismantles the structural arbitrage that makes long-term bank lending deceptively cheap, governance will remain a hollow buzzword, capital markets will remain sidelined, and the banking sector will remain the epicenter of macroeconomic vulnerability.
* Sajed ul Islam is a senior banking executive and financial markets specialist with three decades of global institutional experience across treasury, capital markets, and corporate governance.