Prudential Regulations: Some Key Issues and Their Regulations

Introduction

Definition of Prudential Regulations

Prudential Regulations is a form of regulation which subjects banks to certain

requirements, restrictions and guidelines to ensure the financial stability and reduce
risks in the banking sector. Prudential regulation of banks should be envisaged from
a systemic, broader or macro-prudential perspective. Prudential regulation has as
its objectives the safety of individual institutions and the stability of the financial
system as a whole. Traditionally, such regulation has been primarily directed at
banks. BASEL III is a prudential regulation that aims to reduce the overall risks in the
banking sector by setting up new definition and benchmarks.

Importance of Prudential Regulations

In a financial sector like banking, prudential regulations are of great importance. An

instable or risky banking sector can destroy the economy of a country. Thousands of
people can lose their money. Development of the country may hit an obstacle. Thus,
prudential regulations are there to control the banking sector through certain strict
guidelines and regulations. Generally in banking sector, prudential regulations are
set by the central bank of the country which also follow international practices such
as BASEL. Bangladesh Bank sets the regulations of banking sector here in
Bangladesh. These regulations are set to minimize the risk exposer of the banks and
ensure there are enough shock absorber in place to recover from a financial crisis.

Key Issues and their Regulations

o Capital Adequacy

Capital adequacy is a measure of banks capital in relation to banks risk weighted

credit exposers. Maintaining the minimum required capital banks safeguards both
itself and the depositors from risks of insolvency. Banks capital is categorized in two
tiers. Tier one capital or core capital is the capital that is permanently and easily
available to cushion losses suffered by a bank without it being required to stop
operating. Tier two or supplementary capital is the one that cushions losses in case
the bank is winding up, so it provides a lesser degree of protection to depositors and
creditors. It is used to absorb losses if a bank loses all its tier one capital.
According to Banking Companies Act, 1991, each bank must have BDT 400 crore as
capital with minimum BDT 200 crore paid up capital. Banks must keep a minimum
capital to risk-weighted assets ratio at 10%. Each bank also has to assess and
report their capital position on half yearly basis to Bangladesh Bank.
o

Corporate Governance

Corporate governance is very crucial to a financial institution like bank. Proper

corporate governance ensures that a bank is operated in a systematic compliant
way and minimizes the risk exposer. To ensure corporate governance, the
commanding body of a bank such as the board of director and the top management
must be competent. They must envisage to create an organization where corporate
governance is of utmost importance. Responsibilities and authorities to implement
and exercise proper corporate governance lay with the below parties.

Board of Directors

Chairman of the Board of Directors

Adviser

CEO

Single Borrower Exposure

Credit concentration on single borrower exposes a bank to risks. If a large portion of

the credit is tied to a single borrower and in case the borrower defaults the bank will
be in danger of financial instability. To reduce this risk BB has set the ceiling for
single borrower credit exposer. For a single borrower the total outstanding must be

within 35% of the total capital. Also funded facilities must not be over 15% of the
total capital of the bank. Non-funded facilities can be provided to the single
borrower but keeping the total outstanding within the 35% limit.

Rescheduling of Loans

Rescheduling of loan is a process of creating a new loan that replaces the

outstanding balance on an older loan, and is paid over a longer period, usually with
a lower installment amount. When a client is unable to pay the regular loan then the
loan may be rescheduled so that, the client does not become a defaulter and the
payment of the outstanding is ensured.
To be considered for the first rescheduling client must pay 15% of the overdue
installments or 10% of the total outstanding amount of loan in cash (whichever is
the lower amount). For demand and continuous loans minimum down payment for
rescheduling is given below.
Amount of Overdue Loan

Rates of Down Payment

Up to BDT 1.00 Cr

15%

BDT 1.00 Cr to 5.00 Cr

10% (but not less than BDT 15.00 Lac)

Above BDT 5.00 Cr

5% (but not less than 50.00 Lac)

Write Off

If a bank debt isn't paid, the bank can write off the overpaid bill as a bad debt. In a
write-off, the bank includes a bad debt as an uncollectible loss on its balance sheet. The write-off reduces
the bank's earnings and thereby reduces its taxable income. Loans classified as Bad/Loss can be written
off anytime. Bad/loss classified loan which have been classified as such for 5 years and there is provision
for it, must be written off immediately. Before writing off a loan, case must be filed in the court for legal
action. Banks should have a department solely to recover the written off loans.

Payment of Dividend

Banks can pay their dividend if the following regulations are compliant.

Dividends cannot be paid in cash or bonus shares.

Provisions requirement and capital adequacy must be kept as set by

Bangladesh bank.

External auditor must certify the provisional requirement and capital

adequacy.

For dividend of 20%, an amount which is equal to the excess amount over
20% must be kept in the dividend equalization account.

Banks have to seek prior approval from Bangladesh Bank if there is any audit
issue relating to the dividend payment in the previous year.
o

Interest Rates on Deposit and Lending

Banks can freely set the rates of both deposit and lending. The only exception is the
interest rate of lending in export sector. The highest rate for lending in export sector
can be 7% per annum.
o

Bank Charges

Banks can set their own charges and fees as they deem fit for the service they
provide to the clients. There must not be any discrimination among same group of
clients who are availing the same service. Banks must prepare their schedule of
charge and keep it publicly available in the branches. BRPD must be kept updated
with the schedule of charges.

Recommendation
Conclusion