JULY 23, 2018: FINANCIAL EXPRESS
A new debate has emerged in the financial sector – especially in the banking sector after the Prime Minister’s call for the banking authorities to bring down interest rate to a single digit for boosting investment. This rate is to be at least 6.0 per cent for the depositors and 9.0 per cent for the borrowed fund – thereby leaving the difference between lending and deposit interest rates, known as the Interest/Profit Rate Spread (IRS/ PRS), at only 3.0 percentage point. Much has been written and talked so far in the print and electronic media regarding the topic and it’s likely to continue for some more period.
Bangladesh’s financial system is dominated by banks where the banking sector accounts for around 90 per cent of total assets of the financial sector. At present, there are 65 state-owned (SOBs), specialised and private commercial banks (PCBs) including eight Islami Shariah-based PCBs. This total is often deemed as a huge figure for a small economy of Bangladesh’s stature and consequently, some sort of unhealthy competition and aggressive banking practices are growing in the banking industry. There are also 35 non-bank financial institutions (NBFIs) operating in the country.
It’s a reality that high interest or profit rate and a high IRS raises the cost of credit thereby limiting the access of potential borrowers to credit markets and thus reducing investments while limiting the growth potential of the economy. Moreover, problems become more acute for small businesses, household enterprises and rural industries, which are vital for promoting equitable growth and reducing poverty in low income countries. It is often argued that the higher the IRS, the higher the cost of credit to the borrowers for any given deposit rate. Alternatively, a high IRS could mean unusually low deposit rates discouraging savings and limiting resources available to finance bank credit. Whatever the reality is, the rate of interest should not be fixed by any abrupt decision of the government. Rather, it should be based on well-researched policy of the regulatory authority while being responsive to the market condition. Of late, the government has decided to allow state agencies to deposit 50 per cent of their funds with private banks, up from the existing ceiling of 25 per cent, to tackle liquidity crisis. But those funds will not be so easy for the banks to mobilise.
If we take a look into the financial history of Bangladesh, we can find that the banks were allowed to set lending and deposit interest rates within the bands set by the regulator, Bangladesh Bank, with liberalisation towards a market-oriented interest rate policy under the Financial Sector Reform Programme (FSRP) in the 1990s. Later on, the bands were removed allowing the banks to set interest rates along the lines of market conditions. Finally, other restrictions were removed in 1999 enabling the banks to enjoy greater flexibility in setting interest rates. Despite the removal of restrictions and reforms in the banking sector to facilitate the adoption of a market-oriented interest rate policy, interest rates are yet to become fully responsive to the market where the rate of interest is the rate at which borrowers and lenders decide to borrow and lend money to each other as interest is the rent paid by the borrower to use the funds of the lender.
On the other hand, if we look into the reasons behind lower rate of interest in developed country and higher rate in the developing country, we’ll have a clear idea about the determinants behind such rates. We know that interest or profit rate is the compensation paid for depreciation in the value of currency with time. Thus the higher the inflation rate, the higher would be the interest rate. Since inflation is lower in the developed economies, a lower interest rate follows. Moreover, GDP (gross domestic product) growth rate is also very low for high income economies in general. Besides, their currency has strong exchange rate in the global market. Since growth rate is low, they try to boost via low interest rates. Since high income economies have stable governments and economic policies, inflation is often low ranging from 1.0-2.0 per cent. Therefore, the real interest rate and nominal interest rate have little difference.
For example, Japan has an ageing population and its population is not growing. This has caused the inflation to come to near zero levels. Therefore, the growth of the economy has become stagnated. The negative/low interest rate incentivises people and companies to spend their money in the banks or take new loans. This will help in improving the demand and hence grow the economy.
Researchers, on the other hand, have attributed the existence of high rate of interest and IRS in developing countries to several factors, such as cost of non-performing loans (NPLs), high state control of lending, absence of risk management practices, limited technical skills, administrative and incidental costs, including expenses that the banks incur in setting up new branches, and attracting and retaining skilled personnel, advertising, and other expenditures that the banks undertake to increase market share and business, high operating costs, financial repression, lack of competition and market power of a few large dominant banks enabling them to manipulate industry variables, including the lending and deposit rates, high inflation rates due to huge demand of products and services against limited supply, GDP growth rate, FDI, exchange rate, high risk premiums in formal credit markets due to widely-prevailing perception relating to a high risk for most of the borrowers, and similar other factors.
The analysis also shows that the higher the non-interest income as a ratio of total assets of a bank, the lower is its spread. Similarly, market share of deposits of a bank, statutory reserve requirements, and NSD certificate interest rates affect the IRS. The analysis in terms of bank groups shows that the IRS is significantly influenced by operating costs and classified loans for state-owned commercial banks (SCBs) and specialised banks (SBs); while inflation, operating costs, market share of deposits, statutory reserve requirements, and taxes are important for the PCBs. Besides, non-interest income, inflation, market share, and taxes matter for the foreign commercial banks (FCBs).
But in reality, the rate of interest in both deposit and lending does not remain same in the long run. Eventually, it goes higher than just the double digit – thereby adding various hidden costs, such as service charges, compensation, fines etc. So, whatever is the declared rate, we are observing that the FIs are retaining more from their investment clients, but always try to give less to the depositors than their declared rate imposing various service charges.
There have been unhealthy competition in the financial market in terms of the rate of interest or profit to the depositors. National Savings Bureau and other agencies are offering higher deposit rate in various savings and term deposit schemes. Therefore, as the depositors are becoming looser by keeping their money in the banks, they are diverting to those government saving schemes. Moreover, there are many cooperative societies and personal borrowers and savers who are not institutional and paying much higher rates to the depositors. Similarly, people also find it more lucrative to keep their money into securities or if there is inflation, they will keep it with themselves as that will prevent them from frequent visits to banks. But this scenario is not good for the sound and steady economic growth. Consequently, banks will not be able to mobilise more fund to lend the investment clients, which will be a big obstacle to the industrialisation and sustainable growth of the economy.
The rate of interest or profit should be responsive to the demand and supply prevailing in the market. It should also be based on the actual cost of fund of the bank.
© Copyright: Reserved by the writer (Noore Alam Siddiqui)
