When rule of law is missing, lending becomes a gamble

By all conventional indicators, Bangladesh is facing serious macroeconomic distress, as the International Monetary Fund recently noted.

Inflation remains stubbornly high. The value of the taka has declined significantly. Banks are suffering from a lack of capital, and non-performing loans have risen. At the same time, public confidence in key institutions is declining, especially with regard to the judiciary and financial law enforcement bodies.

The International Monetary Fund, which is currently reviewing the fifth tranche of the US$5.5 billion loan package to Bangladesh, has acknowledged these risks in unusually cautious language. In a statement issued on November 13, the head of mission, Chris Papageorgiou, praised the government’s monetary tightening and efforts to restore foreign reserves, but added a clear warning: “Downside risks remain significant, especially if policy responses are delayed or insufficient.”

Which line It carries a special weight. Concretely, the IMF notes concerns not only about Bangladesh’s fiscal and monetary health, but also about its institutional capacity to implement and sustain reform. This concern should spark a broader conversation about how global lenders deal with countries with weak rule of law, and whether conditionality frameworks keep pace with political realities in many borrowing countries.

Institutional weakness is not limited to inefficiency

International financial institutions have long focused on technical metrics: inflation targets, debt-to-GDP ratios, and interest rate regimes. However, technical factors cannot be separated from the institutional environment in which policies are made and implemented. When regulatory bodies are politically captured, when the judiciary lacks independence, and when implementation becomes arbitrary, even well-designed programs can collapse.

This is increasingly evident in Bangladesh. The IMF itself highlighted the urgent need for reform in the banking sector, noting in its statement that “financial sector reforms are necessary to address the challenges of the banking sector.” Asset quality reviews launched by the Bangladesh Bank have revealed deep capital shortfalls in Sharia-based banks, but this review appears to be only scratching the surface. According to the IMF, the reviews should now be extended to all systemically important, state-owned banks, many of which remain opaque and politically exposed.

At the heart of the problem lies the politicization of basic financial decisions. From setting interest rates to managing exchange rates, policy choices increasingly reflect short-term political priorities rather than long-term economic fundamentals. This erosion of the independence of technocrats has weakened investor confidence and left the central bank unable to act quickly or credibly in response to inflation, currency instability, or financial sector distress.

These are not marginal issues. The International Monetary Fund has urged Bangladesh to make monetary policy more effective by fully implementing the new exchange rate regime and phasing out quasi-fiscal operations. In the absence of a credible and honest central bank, political commitments will lack credibility. Tightening monetary policy becomes performative rather than effective. Exchange rate flexibility becomes merely rhetorical and not tangible, and confidence evaporates, both domestic and foreign.

The rule of law and the problem of selective enforcement

Beyond the banking sector, there is a deeper structural fear – the arbitrary and politicized use of state power to settle scores, reward allies, as well as punish rivals. Legal processes are often viewed as tools of political expediency rather than neutral mechanisms for achieving justice. Companies and individuals find themselves vulnerable to retroactive asset seizures, selective tax audits, or surprise regulatory actions, all of which, not surprisingly, depend on their political bias.

This climate of selective implementation undermines the basic premise of lending for development. IMF support, especially under programs such as the Extended Credit Facility, depends on meeting policy conditions agreed upon in good faith. It is worth asking how reforms can be implemented or sustained if legal institutions are untrustworthy and implementation is politicized.

As for the private sector, the implications are stark. Investors are reluctant to allocate capital when equity can be reversed overnight. Entrepreneurs become less inclined to innovate or expand if they fear regulatory harassment. When foreign companies seek redress, they often find the local legal system unwilling or unable to act fairly.

Lessons from other jurisdictions

Bangladesh is not the only country whose failure to enforce the rule of law has jeopardized economic progress. In Tunisia, for example, the judiciary has come under increasing political pressure, raising concerns about the country’s eligibility for EU support in the future. In Lebanon, the collapse of the banking sector was exacerbated by years of regulatory laxity and nepotism, and exacerbated by a weak legal system. In both cases, economic recovery was halted not only by external shocks, but also by domestic institutional deterioration.

Even in middle-income countries such as Türkiye or Egypt, lenders have become more cautious. IMF programs have faced credibility gaps as fiscal reforms were promised but then watered down or rolled back due to political pressures. In response, some institutions have begun to adapt. For example, the European Bank for Reconstruction and Development (EBRD) now includes governance and rule of law assessments in its country strategies, and explicitly links financing to institutional reform criteria.

The International Monetary Fund also has tools at its disposal. It can structure payments around measurable governance milestones. It can support judicial reform projects in parallel with economic programs. It can work with other institutions, such as the World Bank or the United Nations Development Programme, to help build the legal infrastructure capable of supporting long-term stability.

More importantly, they can refuse to release funds when the institutional environment deteriorates. This should not be seen as a form of punishment, but rather a form of wisdom that can be practiced. Lending without guardrails threatens to enable precisely the kind of behavior that undermines economic credibility.

Turning point for conditions?

Bangladesh may soon become a test case for these evolving standards. As the IMF considers whether to release the next tranche of its loan, it faces a choice. Releasing the funds without stronger commitments to institutional reform would send the wrong signal, not only to Dhaka but also to other countries watching closely. However, insisting on credible improvements to judicial independence, regulatory transparency, and central bank independence would reinforce the message that macroeconomic stability cannot be achieved in the absence of the rule of law.

The IMF is not a political player. But it is, inevitably, an institutional issue. Its credibility depends on its ability to impose its own standards, especially in difficult political environments. In Bangladesh, this means confronting the institutional rot that threatens to undo technical progress. It also means the ability to say no when the foundations for reform do not exist.

Ultimately, no economy can thrive when laws are selectively enforced, regulatory bodies are politically captured, and courts are accountable to authority rather than principle.