Wednesday, 30 November, 2022

BB study suggests lifting cap on lending rates

To curb high inflation, the central bank in a recent report recommended lifting the 9 percent ceiling on bank lending.

The recommendation comes at a time when most nations have adopted a policy to reduce the demand for bank loans by raising interest rates to combat the raging inflation triggered by the global economic crisis and the war in Ukraine.

The government has set a rate of 9 percent for lending and 6 percent for deposits to streamline unhealthy competition in the banking sector, while charging high rates for loans.

The IMF mission, which recently visited the country, also suggested lifting the lending rate cap. Local economists, bankers, and the Bangladesh Association of Banks (BAB) have repeatedly called for rate hikes in the context of high inflation.

Nevertheless, the central bank governor and the finance minister have repeatedly refused to lift lending rate limits.

Bangladesh Bank governor Abdur Rouf Talukder defended his position at a press conference in early August, saying most of the loans are being invested, which creates jobs in the long run.

Lifting the lending rate ceiling at this time will increase the lending rate and harm job creation, he said.

The study report states there is no other alternative than raising the cap because inflation is so high in the country, even though the move will slow the economy's growth.

In addition, the report suggested maintaining a moral pressure on the banks after freeing lending rates so that lending rates do not spiral out of control.

According to the central bank report, the imposition of a ceiling has benefited the industrial sector, with 60 percent of the private sector loans going to industries despite a decline in loans to agriculture and cottage, micro, small and medium enterprises (CMSMEs).

"When interest rates remain low, people take out more bank loans, which is contrary to containing inflation, which is on the rise because of the global financial crisis," said a BB official involved in the report's preparation.

Inflation control is now more critical than GDP growth, and most countries are moving in the same direction, he said.

In reply to a question, he said the lending rate can be increased to 10 to 11 percent from existing 9 percent, if the lending cap is not fully withdrawn.           He thinks that it was a right decision to impose interest rate limit when it was taken in consideration of the reality of that moment, but the reality now has changed.

He added that the demand for loan should be controlled now with lifting the cap to rein in inflation, although taking the decision fully depends on the central bank.

Although demand for loans rose due to the rate limit, growth in bank deposits slipped. It created a mismatch between credit demand and supply, resulting in a fall in funds for loans.

The government has taken steps to curb imports, but it may not be enough to stop inflation.

The central bank thinks that the credit ceiling can be fully withdrawn at this moment as the market-based system can be an appropriate solution to the ongoing supply mismatch.

"It is not logical at all to impose limits on bank lending. The cap has deepened the crisis in the context of high inflation because deposits are not rising. Banks cannot lend money according to the high demand,” Policy Research Institute (PRI) Executive Director Dr Ahsan H Mansur.

The analyst said lifting the cap can raise lending rate alongside increasing the deposit rate, but he believes that the situation won’t go beyond control.

He went on saying that people are now reluctant to park money at banks because of the low deposit rate due to the cap, which has eroded lending capacity of banks coupled with subdued foreign loans due to exchange rate and other issues.

“Once the ceiling is scrapped, lending capacity of banks will rise. The central bank report on the interest rate also indicates that, which is positive,” he predicted.

Even though there is little room for imposing such lending and deposit cap in a free market economy, the central bank imposed 9 percent cap on April 0l, 2020.

In August last year, the central bank also gave a separate directive to provide interest on deposits not less than average inflation rate of previous three months after deposit rate hit the bottom.

But most of the banks are not complying with the directive because of bindings of the 9 percent lending rate.

Average deposit rate in banks slumped to 4.07 percent in August last, which was 4.51 percent in January.

In this context, many depositors are parking their money at unreliable companies with the hope of getting higher interest rates. As a result, credit growth surged to over 14 percent now compared to 8 percent growth in deposits.