Equity Analysis /

Bangladesh: Rate cap and Covid-19 create challenges; MFS the only silver lining

  • Rate cap will lower banks' profitability while Covid-19 has slowed business activities

  • Mobile financial services (MFS) will benefit, our survey suggests that bKash has taken an appropriate promotion strategy

  • In our 29-page report we are bearish on the banking sector overall, but bullish on BRAC for its MFS subsidiary bKash

IDLC Securities
26 April 2020
Published byIDLC Securities

Interest cap and Covid-19 create a challenging business environment. Bangladesh Bank (BB), the central bank of Bangladesh, finally implemented the interest rate cap from 1 April, intending to promote industrialization and spur private sector credit growth. However, this rate cap will lower the banks' profitability. On the other hand, the outbreak of Covid-19 has impacted business significantly due to the lockdown in both local and foreign business activities. Almost all types of domestic businesses will suffer from this local and international lockdown. Hence, banks' asset quality will suffer more and liquidity management will become a great challenge. 

Lower interest rate means lower margins and that also without any volume offset. Banks now will be able to charge a maximum of 9% to any loans except for only credit cards. Earlier banks used to charge 10-12% for corporates, 11-14% for retails and 13-17% for SME business. The rate cap will have a significant impact on banks NIM. On top of that, the Covid-19 outbreak has already slowed down the economy. We expect there will be a further slowdown in business activities due to the slowdown in both local and international demand. 

The economic slowdown from Covid-19 likely to impact asset quality. Bangladesh identified the first Covid-19 patient on 8 March and has reported 4,186 confirmed cases, 127 deaths, and 85 recoveries till now. Bangladesh is currently experiencing a 41-day long ‘holiday’ consisting of a twenty six-day general holiday declared by the government, twelve weekends, and three public holidays. This prolonged shutdown is having a huge impact on small businesses. Besides, the pandemic has hit the RMG sector significantly which employs almost 4mn workers. Due to stagnant business activities in Europe, the largest export destination, Bangladesh has lost USD4bn of work orders (10% of total exports) so far. Besides, the IMF has already declared a world recession because of Covid-19. Bangladesh's economic activities have also slowed due to this local and international demand fall. This economic slowdown will impact the banks' asset quality. We expect a slow loan recovery, especially from RMG segment and SME segments. SME business missed one big festival – Pahela Baisakh (Bengali New year) and might miss another big one – Eid-ul-Fitr. Please note that RMG and SME, together, contribute roughly 40% of the total loan portfolio of the industry. 

Asset quality concern could quickly snowball into a liquidity crisis. BB has issued a circular barring any down gradation of the loan status after the Covid-19 outbreak. This relaxation effectively allows borrowers to defer their installment payments until June. We think banks will face liquidity challenges as their regular cash flow will be significantly hampered in the next few months. Besides, there could be deposit withdrawal pressure from large corporates as well. All these could potentially create a liquidity crunch in the market. 

Regulation relaxation by the central bank could be insufficient. BB has already relaxed a few regulations for scheduled banks including reduction of CRR requirement (150bps) and policy rate (75bps). We expect a further cut in both CRR requirements and policy rate to improve money market liquidity. Besides, there could be further relaxation in loan classification and provision requirements. Bangladesh's government already declared a BDT 807.5bn (USD 9.5bn) stimulus package equivalent to 3.2% of GDP. Of this money, BDT 427.5bn (5.0bn USD) will be refinanced by Bangladesh Bank, and the remaining BDT 380bn (4.5bn USD) is supposed to be financed by the commercial banks. 

MFS gaining pace – the only silver lining. Covid-19 is pushing people to look at alternatives to cash. It is resulting in increased adoption of mobile financial services, particularly electronic payments. Besides, the central bank made it mandatory to disburse the salary of RMG workers through MFS accounts if it is paid with soft loans. bKash acquired 0.9mn new customers in April because of this regulation. We did a market survey to understand the impact of increased marketing expenditure of bKash. Our finding tells us that bKash's expense is bearing fruit. Their merchant wing is making a good start. You can find the details in the full report.

We are bearish on the Bangladesh banking sector; our only pick is BRAC due to its MFS subsidiary bKash. Economic slowdown due to Covid-19 and lower profitability from the interest rate cap are the main reasons for our bearish stance. Asset quality will deteriorate this year, which is our prime concern. Besides, we will see single-digit loan growth in all banks. Among our coverage, we prefer BRAC because of potential value creation from the MFS industry as BRAC holds a 42% economic interest in bKash, as well as the strong balance sheet of the bank. BRAC’s current market valuation (USD 465mn) doesn’t incorporate our bKash valuation of USD 942mn. Our bKash valuation might become very conservative depending on P2B business success. 

Upside to our valuation: i) Withdrawal of rate cap; ii) Coherent policy-making; iii) Faster consolidation/merger; iv) Successful implementation of public AMC to clear problem loans.