Financial sector adjustment credit
 Report No: ; Type: Report/Evaluation Memorandum ; Country: Bangladesh; Region: South Asia; Sector: Financial Adjustment; Major Sector:
                                                              Finance; ProjectID: P009528


December 29, 1995

Bangladesh: Financial Sector Adjustment Credit (Credit 2152-BD)

The Implementation Completion Report (ICR) for the Bangladesh Financial Sector Adjustment Credit (Credit 2152-
BD) in the amount of US$175 million equivalent, approved in FY90, was prepared by the South Asia Regional Office.
Two supplemental credits were later added totaling US$6.4 million. A technical assistance component of the project
was cofinanced through a parallel grant of US$19.4 million by USAID. The borrower's own evaluation of the project
is included in Annex B of the ICR.

The Financial Sector Adjustment Credit (FSAC) supported structural reforms in the financial sector, including the
financial restructuring of the nationalized commercial banks (NCBs). The reform program called for measures to:
liberalize interest rates; improve monetary policy; abolish priority sector lending; strengthen central bank supervision
and regulation of banks; improve debt recovery; strengthen NCBs; and support capital market development. The
reforms were recommended by a Government task force (National Commission on Money, Banking and Credit), and
by the Bank through its economic and sector work.

The macroeconomic framework remained satisfactory during loan implementation. The structural measures sought
under the FSAC were implemented by the Government, even though some of these measures involved delays, as in the
case of NCB restructuring and improvement of debt recovery. The first tranche was released upon effectiveness, but
the subsequent tranches were released with substantial delays: the second tranche by eighteen months; and the final
third tranche by twenty months. Some of the reforms recommended by the Government task force were not integrated
into the operation's conditionality, and the Government did not pursue them. The operational objectives were only
partially achieved. Progress was achieved in interest rates and monetary policy. However, the NCBs did not regain
financial viability; debt recovery was only momentary and it failed to improve; competition in the banking sector
remained ineffective; and banks continued to be risk averse, except in their lending to troubled public enterprises.

The ICR rates the overall outcome of the operation as unsatisfactory, sustainability as uncertain, and institutional
development impact as modest. The Operations Evaluation Department (OED) agrees with the ratings on project
outcome and institutional development impact, but it rates sustainability as unlikely because of the deteriorating
performance in the financial sector. OED also rates Bank performance as unsatisfactory, mainly because of flaws in the
operation's design. For instance, the program did not envisage the privatization of the NCBs, without which their
strengthening proved impossible.

The lessons drawn from this operation include the following: (a) the reforms dealing with the removal of rigidities in
the banking system (e.g., improving debt recovery, restructuring NCBs, and improving bank competition) should have
been dealt with before interest rate liberalization; (b) for effective regulation and supervision, the regulatory authority
should have adequate autonomy and be equipped with necessary technical skills; (c) efforts at debt recovery could be
neutralized by an inadequate legal framework; (d) financial sector reform is closely linked to the successful
restructuring of weak productive sector institutions, which account for most non-performing loans; and (e)
consideration ought to be given to the privatization of poorly performing state-owned banks, which often prove
difficult to reform.

The ICR is of adequate quality. An audit is planned.