Stability of an economy is dependent on optimal combination of several macro-economic factors such as monetary policy, inflation rate, private sector credit growth, political environments etc. The recent downturn in financial sector, steep decline in share market indices, liquidity crisis in commercial banks and intervention of the government in determining the market interest rate indicates that the economy is undergoing a tremendous pressure.
Just one and half years back, commercial banks were loaded with excess liquidity due to the lower demand for private sector credit which forced commercial banks to reduce the deposit rate as low as 5 per cent which was lower than the inflation rate. It implies that depositing money into the banks, depositors were losing their purchasing power as the deposit rate was lower than the inflation rate.Therefore, the depositors who have adequate financial knowledge lost their interest to put their money at banks. Now back to the previous point why did bank loaded with excess liquidity. This can be narrowed down to threepossible factors – first one is, the decline of private sector credit growth due to lack of favourable business environment. The second one is rapid decline of the government borrowing form private commercial banks in order to meet up their budget deficit.
The third one is interest rate arbitrage between developed and developing countries. The lower interest rate in developed countries motivates the businesspersons to borrow money from abroad which is three times lower than the domestic interest rate.When the government lowered their borrowing form private commercial banks, started financing large mega project by selling national saving cerficate at much higher rate at 11% than bank deposits rate of 5%, the financially sound investors started withdrawing their deposits form banks and started investing in national saving certificates (NSC).
The argument of setting higher interest rate on NSC was that they tend to give some benefit to snior citizens and government employees by investing pension fund in mega projects. However, the harsh reality is that majority of investment made by wealthy businesspersons and bankers in NSCs, harming the benefit of poor people. In the meantime, the selling of national saving certificate reached new height; total sales of NSC stood at July’18 BDT 50,530 cores where the initial target was BDT 44,000 cores and total outstanding amount is BDT 2,42,226 cores.
Undertaking a number of mega projects and financing the deficit budget, the government increased the demand for credit in both public and private sectors. As it is an election year the government is trying heart and soul to finish the projects as much as possible and show them to people. In response to the increased demand from public sector, the private sector's demand has also been increased. This high demand for credit form the private sector led to cross the limit of private sector credit growth in December’17 by 1.9%; whereas the private sector credit growth was 18.1% overshooting the target of 16.2%.
In order to control the money supply and tackle the inflationary pressure in the economy, the Bangladesh bank instructed banks to adjust their advance to deposit ratio (ADR) to 83.5% for conventional banks and 87% for Islamic banks, which was previously 85% for conventional banks and 90% for Islamic banks. To comply with the Bangladesh bank instructions, commercial banks started to offload their chunk amount of shares which led to rapid decline of the capital market indices and perplexed the investors. Again, the aggressive lending policy by the fourth generation bankers driven unprecedented challenges to adjust ADR ratio and faced liquidity crisis than ever in the banking industry.
The terrible liquidity crisis in the banking industry lastly required Bangladesh bank intervention to pace the liquidity crisis by reducing the CRR ratio by 1% and repo rate .75 basis point and increasing the deposit of the government enterprises in private banks. It has been considered, according to many economists, to be a policy demising the interest of depositors which ultimately acted as incentive for bankers.The rising market interest rate, which crossed the single digit, fueled by severe liquidity crisis, would further deteriorate the private sector investment which has remained stagnant for few years despite several government incentives. The recent move of the government to determine the market interest rate (deposit rate 6% and 9% lending rate) to support the growth of private sector investment is another action of the Ministry of Finance deserves revision.
In the budget FY-18-19 the government has lowered the corporate tax rate for banking industry by 2.5% so that bankers motivate to lower the lending rate to 9% to boost up the private sector investment. Economists opined that such kind of policy implication will not be much helpful to rectify the prevailing underlying fault line such as poor corporate governance, sprawling amount of non-performing loan and unfair intervention of Bangladesh association of bankers (BAB). The market interest rate is supposed to be determined by market mechanism. Bankers are yet to adjust the deposit rate and lending rate as deposit growth rate is not up to the mark.
If the government would finance their budget deficit by borrowing form banking sector it could have reduced interest expenses from public exchequer and used this fund in productive sectors. Moreover stringent rules of BB would have improved the governance practice of banks and reduced the bubbling up of NPL. The increased efficiency in credit management would increase the loanable fund of banks which could have a positive impact on interest rate. The reduction of higher interest rate in NSCs, balancing of borrowing form NSCs and banking sectors and independent role of Bangladesh bank and check and balance of regulation in banking industry can ensure more stability in banking industry and smooth economic development.
The writer is a graduate from the Department of Finance, University of Chittagong.