After thirty years of financial liberalisation, it seems, it is about time to say in Bangladesh, "Goodbye, financial liberalisation". During the past thirty years, we have witnessed some major transformation in the banking sector: deregulation of both deposit and lending interest rates, development and acceleration of private banks, privatisation of public sector banks, improvement in governance structure and revision of banking companies act, among others. So much has been attained in Bangladesh financial sector. Now all seem to be going in vain! Over the past decades, we have gradually moved back to financial repression. Is it good for the economy and banking sector? So much investment had been made for financial liberalisation in the country with all the projects of Rural Finance Experiment in the seventies, Financial Reform and Rural Finance in the eighties, Bangladesh Bank Strengthening in the nineties and onwards and many others, supported by the World Bank (WB) and International Monetary Fund (IMF). All these reform initiatives were undertaken to ensure efficiency and stability in the financial sector. Financial liberalisation is still a major policy consensus. But financial liberalisation is incomplete without reforms in product and factor markets. That is why we have seen reform processes in those markets along with financial market reform. But who would know that political economy of financial reform would undermine efficient behaviour of financial markets and benefits of financial liberalisation.
The Keynesian economics suggests that low interest rate increases investment; and hence increases economic growth and employment, other things remaining same. While it is true, lower interest rate regime promotes investment but social cost might be high if financial market is not properly regulated. A lower interest rate regime below equilibrium rate will create excess demand for credit and hence it will contribute to inefficient allocation of resources and lower financial development because of lower deposit interest rates, increase in social cost. Research in the last three decades showed that financial development contributed to economic growth through the effective role of financial intermediation.
FINANCIAL REPRESSION: Financial repression has been viewed in different ways. It is considered as a measure to finance government debt. For example, low interest rate with negative or almost zero real interest rate is considered as a repression measure. Such lower real interest rate will encourage government to finance its budget deficit on the one hand, and it will help government in debt reduction on the other hand. But from the perspective of allocation of resources and sustainability of financial institutions, financial repression will have adverse impact on efficient allocation of resources and flow of credit to private sector as well as sustainability of banks. Consequently, default in bank credit will increase. Financial repression is not only about benefitting government in borrowing but also in patronising political allies. This is well documented in the literature. It is evident in many countries including the South Asian countries.
Subsidy and premium are features of financial repression regime. Low interest rate is an important technique of financial repression when such rate does not reflect market rate or the curb market rate. One would certainly expect a lower interest rate when there will be lower demand for credit. Lower lending interest rate implies even lower deposit interest rate that is likely to affect demand for deposit services. Thanks God! Risk of keeping cash under mattresses motivates people to keep money with banks. Savers are now forced to keep money with banks but realistically there is little incentive for depositors to save with banks in Bangladesh. In other words, lowering interest rate (below equilibrium interest rate) reflects providing subsidy to borrowers and lenders.
PUBLIC SECTOR BANKS CONTINUE TO BLEED: Prior to financial liberalisation, public sector banks were dominating players in Bangladesh banking sector. Government always argued for public sector banks for targeted growth and flow of resources in desired sectors and sub-sectors. Cheap credit policy and selective credit policy were major financial policies of Bangladesh Bank. Lower recovery rate and increasing loans outstanding were the outcomes. Financial subsidy provided impetus for political intervention in lending and loan recovery of public sector banks. For example, Tk 1.0 billion (100 crore) targeted selective agricultural credit was disbursed on the recommendation of the union council leaders in the late 70s, and preparation of list of farmers for agricultural credit by the union level political leaders in the late 80s. Agricultural credit was distributed accordingly based on the list prepared. Most loans could never be recovered - high default cost. High default rate also in industrial credit market made the industrial banks bankrupt because of political connection and influence of the political institutions. Sustainability of the public sector banks was adversely affected. Direct budgetary allocation could barely help these banks to survive. Even in financial liberalisation, the public sector banks survive with direct subsidy costing billions for the society and taxpayers. Loan scams in Sonali Bank, Janata Bank, BASIC Bank are evidences of such state. This suggests that public sector banks continue to bleed both in pre-and-post financial liberalisation regimes.
There must be some common underlying factors attributing to the state of public sector banks. They are: political intervention, incentive to default in subsidy based lending, weak regulatory and governance regimes. Weak regulatory and governance regimes are reflected in the inability of Bangladesh Bank and Board of Directors of public sector banks to ensure good governance and efficient allocation of resources.
I personally feel that a few public sector banks may be required for promoting and financing targeted sectors and changing the behaviour of private banks. But governance has to be strengthened. In this case, I expect the public sector banks as leaders in shaping the behaviour of private banks in financial liberalisation regime. Unfortunately that is not the case.
'POLITICS-INDUCED FINANCIAL REPRESSION': With financial liberalisation, private banks have been allowed to function. Direct political interventions in the decision making process does not exist. But it does exist through strengthening political patron-client relationship. In Bangladesh, politicians, businessmen, bankers and regulators all work together to maximise premium. Political leaders and businessmen are promoters of banks; and businessmen and political leaders are in coalition. In such situation, regulators become weak. There is no check and balance in regulation. We may call this repression as 'politics-induced financial repression' for maximisation of wealth. This form of repression is most visible in politically repressed market-based economy. In recent years, we have seen poor performance of first generation banks like AB Bank, family ownership of banks through provision of four members from a family to be on the Board of Directors, and direct subsidy for failed private banks like salvaging Farmers Bank Limited. Salvaging private banks are nothing new in Bangladesh. But who bears the cost? Society has to pay for it. An influential political leader has promoted Farmers Bank. The ideal solution in case of Farmers Bank should have been to allow the bank to fail. Bangladesh Bank within its authority could have come out with a set of measures. They did not; but Ministry of Finance could come out with a strategy to financing capital shortfall of the Farmers Bank through financial support from public sector banks and institutions. Why should society pay for inefficiency of a bank? From the perspective of regulation, Bangladesh Bank should have taken over the bank along with its equity, as they did in the past. Meeting financing capital shortfall of private banks by public sector banks and institutions is a flawed policy, as it will be a precedent in future and it will also affect the subscribing public sector banks and institutions as well, as these banks are already in disarray state. These evidences reflect poor performance and repression of finance in banking sector.
In a liberalised financial regime, one would expect efficiency in private and public sector banks. Evidences as stated above show that the regulatory authority is weak; private banks are family owned with greater authority over allocation of loanable funds and governance; and political patron-client relationships exist in banking. Consequently, finance is repressed from the perspective of regulation, governance and allocation of resources.
THE ISSUE OF INTEREST RATE: In a financial liberalised market, pricing is an important element. It is expected that lending interest rates should reflect market demand and supply. In addition, in a competitive market, a bank will be responsive to interest rates changed by competing banks until the market is fragmented. Probably being imbibed by the Keynesian theory, there is a drive for bringing down lending interest rate to single digit. There is nothing wrong in desiring lower lending interest rate, but this should be done through market mechanism and instruments of regulatory authority. There should be a scientific approach to it. There are many ways of influencing lending interest rates. Central Bank can always give signal to the market by adopting appropriate instruments like bank rate and reducing reserve requirement rates as being done in the western countries. On the other hand, higher deposits mobilisation, given lower demand for credit, will lead to lowering lending interest rate automatically if market is competitive and efficient. Is this the case in Bangladesh? Statistics do not provide support for lower demand for credit. If there is lower demand for credit, banks in a liberalised market should have reduced interest rates much earlier.
Unfortunately, the recent initiatives do not lend support to the notion that banking sector is operating efficiently and independently as benefits of financial liberalisation. Lending interest rates should have been automatically reduced when cash reserve requirement has been reduced. Political leaders in the government can always express their mind or desire to have a single-digit lending interest rates. I do not see any problem when Prime Minister calls for it as the government will always like to promote growth through higher rate of investment. In response to the appeal, very recently Bangladesh Association of Banks (BAB) in a meeting decided to reduce lending interest rates. How can BAB decide about it? The question can be asked in a reverse way: how could the banks continue with higher lending interest rate if interest rates could be reduced? What prompted them to come out with the statement of reducing lending interest rate? Where is competition in the financial market? What has Bangladesh Bank been doing? It should have been the authority of Bangladesh Bank to take necessary measures following the desire of the Prime Minister. The behaviour of BAB suggests that they decide on how banks and financial markets should operate. BAB could act on lending interest rate because of the patron-client relationships. It also suggests that Bangladesh Bank is becoming more and more irrelevant in financial market regulation.
The Bangladesh financial market is already plagued by many financial irregularities, high default rate, political patronisation, growing default and ultimately inefficient allocation of resources. Promoters of banks are businessmen. They derive benefits not only by holding equity but also by borrowing from the banks. There is always interest of the businessmen promoting banks and financial institutions. Therefore, given the conflict of interest of the promoters, banks should be strictly regulated and governed. Unfortunately, the evidences clearly suggest that weak regulatory authority governs banks. When regulatory authority is weak, inefficiency in the banking sector will continue to rise; banks will continue to be weaker. The hard-earned benefits of financial liberalisation in Bangladesh will continue to shrink. Bangladesh Bank needs to be a strong and independent regulatory authority, and regulatory policies and market competition should influence the behaviour of banks and financial institutions. If this is not the case, we may have to say in Bangladesh, "Goodbye, financial liberalisation!".
M. A. Baqui Khalily is a former Professor, Department of Finance, University of Dhaka.
© 2017 - All Rights with The Financial Express