Global credit rating agency Moody’s has downgraded Bangladesh’s banking sector from “weak” to “very weak,” citing deteriorating client confidence, insufficient financial safeguards, and limited transparency over the past year.

The announcement follows a downgrade to Bangladesh’s sovereign credit rating, which Moody’s lowered from B1 to B2, with the outlook shifting from stable to negative.

The downgrade reflects escalating challenges in the country’s banking sector, which has struggled with worsening operating conditions, rising non-performing loans (NPLs), and systemic governance issues. According to Moody’s, a “very weak” rating signals increased financial instability, higher risks to growth prospects, and elevated default risks that could hurt banks’ creditworthiness and profitability.

Top bankers have described the banking sector’s downgrade as a direct consequence of the sovereign rating adjustment. A weaker banking sector typically creates a more challenging economic environment, with ripple effects across the financial system.

“The central bank’s initiative to enhance asset quality recognition is likely to cause a near-term surge in non-performing loans but contribute to systemic stability in the long run,” Moody’s stated in its analysis.

Despite these risks, the ratings agency noted that most banks rated by Moody’s have maintained stable funding and liquidity positions.

Bangladesh’s banking industry has faced significant headwinds recently, including liquidity shortages, rising bad loans, and governance failures. As of September 2024, non-performing loans reached an unprecedented Tk 2849.77 billion. The sharp increase has been attributed to weak credit risk assessments, political interference, and lax regulatory oversight during the previous Awami League government’s tenure.

A number of private Shariah-compliant banks and state-owned institutions have been at the center of controversy. They are accused of engaging in large-scale loan irregularities linked to politically connected entities, which has further eroded confidence in the banking sector.