Governance-Finance Nexus: Bangladesh

Executive Summary

Governance is Bangladesh's binding economic constraint, not capital, not demographics, not geography. The WGI composite of 22.5 out of 100 places every dimension of institutional quality in the bottom quartile globally, and the consequences are measurable across every sector this analysis covers. The banking system carries an NPL ratio of 9.6%, which rises to 19.2% once governance-enabled regulatory forbearance is stripped out, pointing to a systemic asset quality problem rooted in directed lending and captured supervision rather than cyclical credit stress. Tax revenue at 7.64% of GDP is 0.5 percentage points below governance-predicted levels (moderate gap), driven not by rate inadequacy but by an enforcement apparatus corrupted at origin (CPI 28.0/100). Estimated corruption leakage of $15.8 billion per year, equal to 5.0 times total public health spending, is a resource diversion that dwarfs any plausible tax reform. The base case is continued stagnation in all three domains. The reform case, contingent on the July 2024 transition window, is quantified in each section below.

Institutional Quality and Financial Health

Composite governance-financial health score: 52.2/100 (moderate).

Bangladesh's WGI composite of 22.5 is not a technocratic statistic. It reflects the operational reality of every institution involved in credit allocation, contract enforcement, and regulatory supervision. Governance weakness acts as a direct amplifier of financial system fragility through three mechanisms.

First, loan classification credibility. The reported NPL ratio of 9.6% is already high by regional standards, but it relies on classification standards enforced by a supervisor (Bangladesh Bank) operating at the 22.5 WGI percentile for government effectiveness. Adjusted for the credibility discount that governance quality implies, the effective NPL rises to 19.2%. This creates a 7.7 percentage point stability gap between governance-adjusted NPLs and the capital adequacy ratio, a signal that headline capital adequacy figures overstate true resilience.

Second, contract enforcement. The judiciary backlog of 3.7 million cases renders loan recovery slow and uncertain. Creditors price this recovery discount into the cost of credit, raising spreads and suppressing productive lending.

Third, directed lending. Control of corruption at the 17.0 percentile is the institutional precondition for connected borrowing in state-owned commercial banks, the dominant driver of SCB asset deterioration addressed in the final section.

Peer benchmark. Vietnam, with WGI scores averaging approximately 40 (versus Bangladesh's 22.5), maintains bank NPLs around 2%. India, at WGI scores near 50, implemented the Insolvency and Bankruptcy Code that reduced gross NPLs from 11.2% to under 4% within five years. The governance-asset quality relationship is causal, not correlational. Bangladesh will not resolve its NPL problem without resolving its governance problem.

The Tax-Governance Gap

Tax collection: 7.64% of GDP. Governance-predicted level: 8.1% of GDP.

Bangladesh is 0.5 percentage points below governance-predicted levels (moderate gap). This is not a tax rate problem. Vietnam collects 18% of GDP in tax with a similar income level. The structural causes are institutional.

• Compliance rate: 0.69% of the population files tax. The National Board of Revenue lacks the IT infrastructure, audit staffing, and political independence to expand the base. TIN registration exists on paper; enforcement does not.
• Corruption revenue loss: 24.9% of potential revenue. When businesses observe that the tax system rewards those with connections and punishes those without, voluntary compliance collapses. This is a governance externality, not a behavioural anomaly.
• Political tax expenditure. Tax holidays, preferential rates, and discretionary exemptions, estimated at 2-3% of GDP, are the direct output of a tax authority that operates without genuine political insulation.

Reform dividend. If governance effectiveness improved to the 50th WGI percentile, the resulting uplift would add 2.9 percentage points of additional tax capacity, equivalent to $13.0 billion per year, without a single rate increase. This quantifies what is at stake: fiscal transformation is a governance reform, not a rate schedule revision.

Risk case. LDC graduation beginning 2026 removes concessional financing buffers precisely when domestic revenue remains constrained. The combination of tightening external financing and stagnant domestic mobilization narrows the window for productive public investment.

The Cost of Corruption

CPI 28.0/100. Estimated leakage: $15.8 billion per year, $91 per capita.

These are conservative estimates derived from cross-country empirical leakage rates at comparable CPI levels. The leakage rate of 3.5% of GDP implies that public resources are diverted at a scale that structurally crowds out development spending.

The opportunity cost benchmark is stark:

• Leakage exceeds public health spending by 5.0 times. Bangladesh allocates 0.7% of GDP to public health, among the lowest globally for a country at its income level, while corruption drains 3.5% of GDP through procurement inflation, fund diversion, and ghost service delivery.
• Leakage exceeds public education spending by 1.8 times. At 2.0% of GDP, education is funded at less than half the UNESCO benchmark of 4-6%; corruption consumes the equivalent of the sector's entire budget and more.
• Infrastructure cost inflation of 20-30% above regional benchmarks is a direct procurement corruption output. Every taka of Annual Development Programme spending delivers 70-80 paise of actual infrastructure. This is not inefficiency; it is systematic rent extraction.

Reform case. A 10-point improvement in CPI (e.g., from 23 to 33, the level of Kenya or Sri Lanka) would reduce leakage from 3.5% to approximately 2.5% of GDP, freeing resources equivalent to a doubling of the health budget. This is the most powerful fiscal instrument available to Bangladesh and the least politically convenient.

Regulatory Friction and FDI Deterrence

Regulatory friction index: 68.4/100 (highly constrained). FDI: 0.69% of GDP.

The friction index aggregates three dimensions: WGI regulatory quality at the 22.0 percentile, Doing Business rank 168, and 19.5 days to register a business. The direct financial consequence is an FDI shortfall of 1.81 percentage points below the peer average of 2.5% of GDP, equivalent to $8.3 billion in foregone annual investment.

Three mechanisms connect regulatory quality to investment suppression:

• Discretionary enforcement. Opaque licensing and frequent regulatory changes create policy risk that institutional investors price out. Vietnam reduced business startup time to under five days; Bangladesh requires 19.5.
• Press freedom rank 165. Investor due diligence depends on independent journalism and public information flows. At rank 165, Bangladesh's information environment is opaque to cross-border investors assessing country risk.
• Commercial dispute resolution. Weak rule of law converts a contractual dispute into years of court proceedings with uncertain outcomes, raising the effective cost of doing business by a premium that advanced-economy investors will not absorb when alternatives exist.

Peer benchmark. Vietnam attracted 6% of GDP in FDI in 2023 with WGI regulatory scores roughly double Bangladesh's. Malaysia and the Philippines, at comparable income transitions, both exceeded 3.5% of GDP in FDI before their governance environments improved. The path is established. Bangladesh is not on it.

Fiscal Space Under Governance Constraint

Public debt: 40% of GDP. Nominal headroom: 20.0 percentage points of nominal headroom to the 60% conventional threshold. Effective fiscal space: 10.4 percentage points.

The headline debt position appears manageable. The effective position, adjusted for governance quality's impact on spending efficiency and borrowing costs, is substantially tighter. The 10.4 percentage points of effective fiscal space reflects what Bangladesh can productively borrow and spend, not what is arithmetically available before breaching a debt ceiling.

Four governance-fiscal transmission channels:

• Spending efficiency drag. Low government effectiveness means Annual Development Programme utilization runs at 80% and infrastructure cost inflation consumes 20-30% of project value. Borrowed capital produces substantially less economic return than the nominal investment would suggest.
• Debt service crowding. Interest payments already consume 32.7% of tax revenue. With tax collection at 7.64%, the denominator is too small and the numerator is growing; further borrowing compresses the space for productive expenditure faster than it adds capacity.
• Governance premium on borrowing costs. Weak WGI indicators (effectiveness 26.0 percentile, corruption 17.0 percentile) embed a sovereign risk premium in all non-concessional debt. Bangladesh pays more to borrow less effectively.
• LDC graduation tightening. The shift from IDA to IBRD terms beginning 2026 adds 200-300 basis points to marginal borrowing costs at precisely the moment domestic revenue remains structurally constrained.

Base case versus reform case. Base case: fiscal space erodes as debt service rises and tax revenues stagnate at 7.64% of GDP. Reform case: governance improvement to the 50th percentile unlocks 2.9 percentage points of additional tax capacity, equivalent to $13.0 billion per year, converting the fiscal constraint from binding to manageable without requiring significant new borrowing.

State Bank Governance Risk

SCB NPL ratio: 42.8%. System NPL contribution: 100.0%. Recapitalization cost estimate: $20.3 billion. Governance risk composite: 80.7/100 (systemic risk).

The six state-owned commercial banks controlling 25.0% of system assets are the most concentrated point of governance-financial system intersection. At 42.8% NPL, these institutions are not commercially viable on any standalone basis. They survive through implicit government guarantees, which convert their credit losses into deferred fiscal liabilities.

The governance risk composite of 80.7/100 reflects three reinforcing vulnerabilities: asset quality deterioration from directed lending (weighted 40%); weak accountability at the 28.0 percentile for voice and accountability (30%); and corruption at the 17.0 percentile (30%). The ACC files approximately 850.0 cases annually, a volume that creates no meaningful deterrent effect at the scale of lending abuse occurring across six institutions.

The $20.3 billion recapitalization cost is a lower bound based on a 25% recovery rate on SCB NPLs. Without governance reform, this figure is not a one-time cost. Indonesia's 1998 bank recapitalization, equivalent to 50% of GDP, failed to produce lasting NPL resolution until the KPK began prosecuting bank fraud and independent boards replaced politically connected management. Bangladesh faces the same dynamic on a smaller but still significant scale: recapitalizing without restructuring governance recreates the conditions that generate NPLs.

Priority Recommendations

Four actions, sequenced by impact and institutional feasibility:

1. State bank restructuring with governance as a precondition, not an afterthought. Independent boards, professionally appointed management, and transparent credit approval processes must precede, not follow, any capital injection. The $20.3 billion recapitalization cost is only defensible if directed lending is structurally disabled. Malaysia's Danaharta-Danamodal model, which separated asset management from bank rehabilitation under independent governance, is the relevant precedent.

2. Digital tax administration to close the governance-tax gap. E-filing, e-invoicing, and TIN-NID linkage reduce the discretion that enables corruption-driven evasion. The target is not a rate increase but a compliance rate increase: from 0.69% toward the 10-15% filing rates seen in comparable lower-middle-income economies with functioning tax authorities. This path unlocks 2.9 percentage points of additional tax capacity, equivalent to $13.0 billion per year.

3. Regulatory streamlining targeted at FDI-critical bottlenecks. One-stop investment windows, time-bound licensing decisions with legal recourse for delays, and independent commercial arbitration would reduce the 68.4/100 friction index at lower institutional cost than broader governance reform. The prize is closing the FDI gap of 1.81 percentage points below the peer average of 2.5% of GDP, equivalent to $8.3 billion in foregone annual investment, which compounds into technology transfer and employment effects.

4. Anti-corruption as fiscal policy. The $15.8 billion in estimated annual leakage at a CPI of 28.0/100 exceeds the yield from any plausible tax reform. Strengthening ACC independence with prosecutorial autonomy, expanding the e-Government Procurement system to all tiers of government, and mandating public asset declarations for officials are investments with fiscal returns that far exceed their administrative cost. Each 10-point gain in CPI at Bangladesh's current level translates to approximately 1.5% of GDP in reduced leakage based on cross-country empirical estimates.

The July 2024 political transition creates a reform window that is narrow and contingent. Governance reform has no credible substitute: financial sector repair, fiscal expansion, and FDI attraction all face the same institutional ceiling. The question is not whether the constraint is real but whether this window will be used.

Data sources: World Bank Worldwide Governance Indicators 2023, Transparency International CPI 2024, Bangladesh Bank Financial Stability Report 2024, Ministry of Finance, National Board of Revenue, IMF Article IV, World Bank WDI, UN Comtrade.