The global credit rating agency Moody's has assessed that the outlook for Bangladesh's banking system is negative — despite the country's robust economy — because of the deterioration in the banks' asset quality.

"Asset quality has been worsening in the highly fragmented banking system," says Tengfu Li, a Moody's Analyst.

"Underlying weaknesses in corporate governance, especially at state-owned banks, have led to nonperforming loan ratios rising to 10.4% as of June 2018. The growing stock of unclassified rescheduled loans poses further risk to asset quality."

However, the rating agency has kept its rating for the country unchanged at ‘Ba3 stable’.

"Bangladesh's economy will continue to grow, because of its globally competitive ready-made garments industry," add Li. "Steady credit growth and the rebound in remittance inflows will also support domestic consumption."

Moody's conclusions are contained in its just-released "Banking System Outlook - Bangladeshi banks: High asset risks drive negative outlook despite robust economy".

The outlook expresses Moody's expectation of how bank creditworthiness will evolve in this system over the next 12 to 18 months.

Moody's outlook is based on six key drivers.

It assessed that the banks' operating environment as stable; asset risk as deteriorating; capital as deteriorating; profitability and efficiency as deteriorating; funding and liquidity as stable; and government support as stable.

Moody’s is of the view that credit costs will rise, in tandem with the deterioration in asset quality and such a situation will lead to an erosion of the banks' profitability, especially when the expansion of net interest margins will also be limited under regulatory pressure.

Capitalization will moderate, because of weaker capital generation, despite earnings retention by the private sector banks to meet the higher capital requirements beginning in 2019, the outlook said.

State-owned banks will remain undercapitalized, and dependent on capital infusions from the government, it said.

Banks in Bangladesh will continue to maintain adequate funding and liquidity.

While financial conditions tightened during the first half of 2018, the situation has stabilized after monetary easing measures were implemented.

The lower limit on the regulatory advance deposit ratio — which will come into effect in March 2019 — will further mitigate funding risks, it believes.

Moody's expects the Bangladesh government to remain supportive of the banking system, given the government's track record of taking preemptive measures against banking failures.

The government also has the capacity — as reflected in the country's modest general and external debt burden — to support the banks in times of need.