Up until recently, Bangladesh’s economy was growing at a rate of 8.2 %. A reduction in poverty took place at a staggering rate. The rate of poverty declined to 10.5% in 2018–2019 compared to 31.5% in 2010. During that time over 25 million people were brought out of poverty. In this miraculous growth, Cottage, Micro, Small, Medium Enterprises (CMSME) have made a key contribution by creating employment for 7.8 million people directly and providing livelihoods for 31.2 million people.[1]

However, all these achievements risked coming to a stall when the Bangladesh had to resort to months-long lockdown measures in March 2020. As the economy braced for the impact of the covid-19, stimulus packages of USD 17.5 billion were declared by the Government of Bangladesh to ensure a soft landing for the economy. Of this USD 17.5 million stimulus, USD 2.4 billion was specifically set aside for CMSME sectors. Despite the stimulus package, the pandemic precipitated the loss of jobs and earnings, leading to an increase in the rate of poverty from 12% in 2019 to 30% in 2019–2020.[2]

One cannot wonder but why, despite the increased liquidity created by the stimulus and a liberal monetary policy effected by the central bank, the reduction in employment and loss of earnings could not be averted. One year after the declaration of various stimulus packages, several publications have started reflecting on the implementation of the stimulus. A common undertone shared by all these publications was that the benefits of the stimulus packages have not reached the small businesses. Rather, the large borrowers, who were already sizeable and established, have mostly reaped the benefits.

At first glance, this would appear to be nothing but a systemic bourgeois preference of Bangladesh’s banking system. But is there something more to it? This article takes a deeper look into it.

Challenges of lending to CMSMEs

In Bangladesh, CMSMEs are defined as those entities having assets between less than BDT 1 million (around USD 11,700) to BDT 300 million[3] (around USD 3.5 million). Given the wide-ranging definition, the businesses which may be considered an CMSME vary considerably, both in their nature and size. The CMSME sector may include a potter in a remote Bangladeshi village, but it may also include an urban-based industrial operation. Moreover, a large part of growing e-commerce markets and start-ups across Bangladesh are also part of the CMSME sector.[4]

Though the discussions about limited access to credit has become more mainstream during times of covid-19, this had been a persistent problem in Bangladesh even before the pandemic. For instance, a World Bank memorandum identified access to credit as one of the major growth inhibitors for Bangladeshi businesses.[5]

Bangladesh’s financial institutions are not to be solely blamed for the apparent inequity in the distribution of loans.

The process is simple: limited access to credit affects the growth of businesses which in turn erodes employment growth. This is evidenced by the increased unemployment rates in Bangladesh, which, despite outperforming economic growth, stand at odds with all the positive indicators of the economy. The unemployment rate stood at 5.3% in 2020, up from 4.22% in 2019 and 3.38% in 2010. Bangladesh’s financial institutions are not to be solely blamed for the apparent inequity in the distribution of loans. Various factors have played a role in shrinking credit flows to the private sector, alongside information asymmetry and capped interest rates. These factors include high costs of financing CMSMEs and the informality in the business structures of many CMSMEs. As a result, credit flows to the private sector declined from 11.3% in 2019 to 8.6% in 2019-2020. As of January 2021, it has further declined in 2020-2021 to 8.3% (year-on-year).[6]

The information asymmetry problem

Banking is an activity that by definition involves taking deposits from the public to transfer loans or investments to borrowers.[7] Since the banks are dealing with public money, it is of utmost importance that the banks conduct due diligence of any potential borrowers to manage their credit risks. In Bangladesh, under the Prudential Regulations for Banks 2014, banks ought to manage five core risks including credit risks associated with its business. Bangladesh’s Prudential Regulations for Small Enterprises Financing unequivocally states that loans will be given ‘only after proper verification of customer’s static data and after proper assessment and confirmation of income-related documents, which will objectively ascertain customer’s repayment capacity.’ It therefore follows that ‘risk assessment’ is a mandatory activity for Bangladeshi banks before they choose to invest in someone.

An assessment of risks, by its very nature, is grounded upon the availability of information. However, in a country with approximately 85% of the workforce engaged in the informal economy, it is no surprise that many CMSMEs are unable to provide the necessary information to demonstrate their ability to repay loans. The lack of information on potential borrowers creates information asymmetry. The lenders have limited information about businesses, deterring many lenders from providing loans.

While many lenders would have otherwise chosen to finance such risky borrowers at high interest rates, many banks choose not to because of the cap on interest rate. This information asymmetry essentially justifies the interest rates charged by Micro-Finance Institutions (MFI) which can be as high as 27%. These high interest rates by MFIs also demonstrate that MFI finances are not the efficacious alternative to bank financing.

In conducting risk-assessment, banks evaluate the financial position of borrowers by analysing various datasets, including income statements and balance sheets. Dependence on formal documents like an income statement has the propensity to automatically exclude borrowers lacking corporate sophistication. In the context of Bangladesh, it is a common trait because there is a boom of home-based businesses in both urban and rural areas. Consequently, use of business data from other sources like Mobile Financial Services (MFS) accounts, bank accounts, consumer accounts, utility payments, and government accounts could provide a snapshot of the financial position of a borrower. The opportunity posed by the large reservoir of data would be more evident if one looks at Bangladesh’s MFS statistics. Currently, there are 100.6 million accounts on which transactions of USD 118 million take place every day.[8] Yet the data generated by these transactions are hardly accessible by commercial banks and other financial institutions.

The current state of information on potential borrowers can at best be described as fragmented data stored across silos in unconnected warehouses that are maintained by financial, governmental and business entities. In the absence of a framework for safe and real-time data sharing between lenders and borrowers, a critical opportunity to expand credit coverage to CMSMEs remains largely untapped.

Information reporting for access to credit

The central bank of Bangladesh, Bangladesh Bank, set-up a Credit Information Bureau (CIB) in 1992. Since October 2015, CIB’s online services are being provided through a newly developed CIB Online Solution. From April 2018, Bangladesh Bank took a policy decision to lower the minimum amount for loans to be reported to the registry from BDT 50,000 (around USD 600) to BDT 1. The policy essentially expanded coverage for people within the credit reporting system.

Despite the widened coverage, as of 2020 the CIB system covered only 5.2% of the population.[9] Unfortunately, CIB does not include data on MFI borrowers or mobile financial service users. As a result, this database only remains useful for businesses with a recent borrowing history from a formal financial system. Businesses without loans or with loans from friends and family or MFIs are not adequately covered by the CIB database.

Setting up Account Aggregator

The CIB system operated by Bangladesh Bank provides no data on a potential new borrower. If a borrower with no indebtedness history wants to obtain a loan, they would have to go to a financial institution where they have an account. There they can collate the information on financial assets, and subsequently the lending institution has to physically verify the submitted information. This entire process is onerous, uncertain, time-consuming and costly.

An Account Aggregator would essentially be a third party, ideally licensed and regulated, that would maintain the digital architecture of a trusted platform on which registered users can link details of their financial holdings.

In Bangladesh, the availability of an electronic system to enable borrowers to provide lenders with verifiable information about their financial assets could present a solution to this information asymmetry. This is where the role of Account Aggregators (AA) comes into play.  An AA would essentially be a third party, ideally licensed and regulated, that would maintain the digital architecture of a trusted platform on which registered users can link details of their financial holdings.

The AA system can issue an electronic request setting out details of the data for any potential lender. The lender’s request would be communicated to the borrower by AA. The borrower can then authorise the AA to share the requested data with the potential lender. Security mechanisms should also be in place to ensure the confidentiality of the data.

The entire AA operation may allow users to opt-in and opt-out. This would ensure that data is used for the purpose of risk assessments by the lenders, as permitted by the user. Access to the data from the AA allows lenders to see the financial position of a borrower, and thus the lender can assess the feasibility of a loan. Daily data such as utility bills and tax payments can greatly help the lenders with this assessment.

Can Account Aggregator be implemented within the current legal regime?

Bangladesh’s prime digital security law, the Digital Security Act, 2018 (DSA), criminalises, inter alia, the handing-over or transfer of any data by allowing illegal access to any financial or commercial organisation.[10] This would appear to be the salient restriction in establishing an AA in Bangladesh. However, the offences under the DSA are predicated on the access, collection or transfer of data being unlawful or unauthorized. An AA may be exempt from liabilities for being authorised by law and with consent to the transfer of data.

There is no law in Bangladesh that permits the collection, transfer or exchange of data by a third party. Now the key question is: if a new law is to provide for such authorisation, would this need to be promulgated by parliament? Or can it be proclaimed by a financial system regulatory body?

In Bangladesh, the central bank is the principal regulator of the financial system in Bangladesh. Bangladesh Bank’s website describes ‘Payment Systems’ as ‘the means by which funds are transferred among financial institutions, businessess and individuals and are considered to be the critical factor for the proper functioning of a country’s financial system.’[11]

Since an AA would act as an enabler in exchanging financial information between potential lenders and borrowers, it is arguable whether it falls within the purview of the payment system. The term is generally understood to involve the ‘transfer of funds,’ which is not an activity an AA would engage in.

In case of an AA, Bangladesh Bank may proactively regulate and set the parameters of establishment. Bangladesh Bank’s regulatory set up will fulfil the legality requirement of an AA’s operation. The bank, within its mandate from the Payment Systems under Bangladesh Bank Order 1972, can attain the power to publish a corresponding circular.[12] This will also instill confidence in AA users.

Bangladesh Bank already has regulations restricting information-sharing with third parties. For example, Bangladesh Bank’s Code of Conduct for Banks and Non-banking Financial Institutions 2017 requires banks to ensure the complete secrecy of customers’ information.[13] Customers are also prohibited from disclose their financial information with any third parties.[14]

Taking the existing regulatory framework into consideration, it is apparent that Bangladesh Bank is in a position to implement an Account Aggregator.

Taking the existing regulatory framework into consideration, it is apparent that Bangladesh Bank is in a position to implement an Account Aggregator. There is no need to resort to a new law, an important detail important to bear in mind should Bangladeshi policymakers choose to proceed with an AA.

The need of the hour

Implementation of an Account Aggregation system has the potential of making a paradigm shift in the lending approaches in Bangladesh. Availability of cash flow-based data inputs such as income statements and tax returns would provide a snapshot of someone’s financial assets. It would enable lenders to make cash flow-based lending over asset-based lending. If Bangladesh’s central bank proceeds to establish an Account Aggregator, a repository of datasets would be put to optimal use. In other words, this system can alter the livelihoods of people everywhere in the country. If Bangladesh wants to meet its goal of being the higher, middle-income country by 2031, it is high time to implement the technology to allow for the centralised usage of data.

 

[1] Covid-19 Impact on Bangladesh’s SME Landscape, 2020, LightCastle Partners.

[2] Bangladesh Development Update, April 2021, The World Bank.

[3] Bangladesh Bank SMEPD Circular No. 2 dated 05 September, 2019.

[4] For trading businesses with assets up to BDT 20 million ($240,000) will be regarded as CMSME, according to Bangladesh Bank SMEPD Circular No. 2 dated 05 September, 2019.

[5] Doing Business Reform Memorandum, January-2017, World Bank.

[6] Bangladesh Development Update, April 2021, The World Bank.

[7] Section 5(ত) of Bank Companies Act, 1991.

[8] Bringing unbanked poor under financial services, Shahiduzzaman Khan, The Financial Express in January 15, 2020.

[9] Ease of Doing Business Report- 2020, The World Bank.

[10] Section 33.

[11] Bangladesh Bank’s mandate for regulating Payment System so as to facilitate payment systems innovation in the country is derived from section 7A of Bangladesh Bank Order, 1972.

[12] It is also the exception under section 77 of Bangladesh’s Penal Code when data is accessed, collected or transferred.

[13] Clause 5.2(b) Bangladesh Bank’s Code of Conduct for Banks and Non-banking Financial Institutions 2017.

[14] Clause 2.11.01 (3) Guidelines for Customer Services and Complaint Management.

 

Photo ©️ Mahmud Hossain Opu

Farhana Khan
Farhana Khan is a partner of A.S & Associates and an advocate at the Supreme Court of Bangladesh. She is a lawyer. She was a member of the Bangladesh Investment Development Authority’s consultation team for improving Bangladesh’s ranking in the World Bank’s Ease of Doing Business Index. She is the Legal and Regulatory Specialist for the National Single Window Implementation and Strengthening Customs Modernisation project of Bangladesh’s National Board of Revenue. She pursued her graduate studies in law at City, University of London and was called to the Bar of England and Wales by Lincoln’s Inn.