DHAKA — Bangladesh’s banking sector is girding for a rougher ride after Moody’s, one of the big three global rating agencies, downgraded its outlook for the sector from “stable” to “negative.”

Economists and financial analysts say last week’s downgrade is a major blow for an economy hobbled by a weakened currency, high inflation and declining foreign reserves amid the global shock waves from the Ukraine war. They warn that cross-border financial transactions will become more difficult and costly for the import-dependent South Asian nation. Some overseas institutions have already curtailed credit limits for Bangladeshi banks, according to sources.

“The writing was pretty much on the wall,” Syed Mahbubur Rahman, former president of the Association of Bankers, Bangladesh, told Nikkei Asia regarding the Moody’s alert.

“Despite the dollar crisis, many of our banks were … able to manage transactions with foreign counterparts because of long-term relationships and confidence [in] each other. Now that the whole banking system is being formally certified as riskier, it will significantly hinder our cross-border transactions,” Rahman said.

The downgrade has troubling echoes of similar decisions taken by ratings agencies on Sri Lanka before the country entered a full-blown economic and political crisis. While some experts caution against drawing such parallels, the negative outlook could signal a reckoning for the Bangladeshi banking sector, which has been plagued by scams, corruption allegations and nonperforming loans that as of December accounted for 8.16% of the total loans disbursed.

This week, Dubai-based Mashreq Bank and Standard Chartered’s Hong Kong office declined letter of credit openings for at least two Bangladeshi banks, according to high-ranking executives who preferred not to be named. But even before the outlook darkened, the dollar crisis was stalling new credit arrangements and payments on previous ones.

Data from Bangladesh Bank, the central bank, shows the number of new letters of credit slumped 14% on the year in July to December last year. Payments on those debts declined by 9%. Bankers say they simply do not have enough dollars to settle import bills.

Local media reported that around 20 banks with negative balances in their foreign currency holdings could not make such payments. The squeeze comes as Bangladesh’s official foreign reserves have fallen below $32 billion from a high of $48 billion in August 2021, while the value of its currency, the taka, dropped by 27% from 84 to the dollar to 107 in a span of six months.

The International Monetary Fund, which recently granted a $4.7 billion loan package to Bangladesh, has expressed serious concerns about the continuing growth of bad debts and asked the government to revamp the banking sector by strengthening regulation and supervision.

Mezbaul Haque, a spokesperson for the central bank, told Nikkei Asia that efforts toward institutional reform of the whole banking sector were already underway. “There will be some amendment to the banking and finance laws as well,” he said.

The pressure for better oversight comes after what Zahid Hussain, former lead economist with the World Bank office in Bangladesh, described as a decade of deterioration in the country’s financial system and the banking segment in particular, often punctuated by high-profile scams.

“The problem is not necessarily that these happened, but [that the cases] happened with impunity,” Hussain said, adding that responses to the problems have ranged from outright denial to downplaying their importance. He claimed that regulatory reticence and inaction against malpractice in state-owned banks and, of late, several large private banks caused the already “eroding confidence to reach a tipping point towards downgrading.”

In December, Moody’s lowered the rating of Social Islami Bank, one of the largest Shariah-based banks in the Muslim majority nation of 170 million people, after the institution lost around $1.6 billion in loan scams. The agency also put the ratings of seven other Bangladeshi banks under review for downgrades.

Jyoti Rahman, an Australia-based Bangladeshi economist, agreed that while agencies like Moody’s make assessments based on quantitative analyses, they also likely took into consideration corruption scandals and controversies surrounding the sector. “This downgrading will obviously make finances costlier. If banks are unable to pass on the higher cost of borrowing … then this could add to the liquidity problems in the sector as well,” he said.

Increasingly, Bangladesh finds itself the subject of unwelcome comparisons to neighboring Sri Lanka. Both countries, along with Pakistan, went to the IMF for support last year.

Toward the end of 2020, three major ratings agencies — S&P Global Ratings, Moody’s and Fitch Ratings — downgraded Sri Lanka’s credit ratings, expecting deterioration due to a lack of favorable economic and fiscal indicators.

Sri Lanka later fell into severe economic turmoil, with soaring prices, dire shortages of essentials and huge protests that ultimately doomed the presidency of Gotabaya Rajapaksa last year.

Zia Hassan, author of the book “Development Mirage,” which took a critical look at Bangladeshi economic and financial data, told Nikkei Asia that it is unlikely things will go as badly in the country as they have in Sri Lanka. Bangladesh also saw some positive glimmers late last year.

“But few predicted that 2022 would be as grim as [it turned out to be] for Bangladesh,” he said. “Even Moody’s issued a rosy outlook in March 2022. But now, in a staggering reversal of fortune, it has downgraded the rating for the whole banking system.”

Moody’s, meanwhile, has also begun reviewing Bangladesh’s long-standing Ba3 rating. Hassan fears the Bangladeshi economy will be set back decades if the country’s sovereign rating is lowered as well.

“Bangladeshi authorities need to correct a lot of misdeeds,” he said. Questioning the reliability of the country’s data, he said the first priority was to reveal accurate numbers on foreign reserves, gross domestic product, inflation and nonperforming loans. “Global agencies are watching, we can’t fool them with skewed data,” Hassan said.