SMART as the basis of fixing lending rate: how far smart?

There remain reasonable grounds to hypothesise that borrowers, lenders, and also depositors are likely to be smart at SMART-based lending rate. Such an apprehension springs up not from sheer fault-finding, rather from tremendously volatile trends of Six-month Moving Average Rate of Treasury bill (SMART) as observed over a period of 10 years. The more the involvement of a financial institution in a securities market trading, especially as debt instrument, the greater the degree of market risk. Let us go deep into the issue to examine our proposition.

It is observed from the table that SMART varies more than 11 times over a period of 10 years. Even the recent past (FY21 to FY23) registered very uneven trends ranging from 0.85 per cent  to 7.10 per cent  So, the following questions crop up:

1. SMART is sure to vary and its variation would cause a change in the lending rate every month. Would it be a consistent pattern for loan interest rates to vary frequently i.e., each month?
2. A lender's biggest source of loanable fund is deposit. What would be the relationship of lending rate with the deposit rate?
3. Lenders must have a reasonable level of spread to earn profit and survive at least at the break-even level. What would happen to the level of spread?
4. Has there been any analytical study prior to deciding on new lending rate based on SMART?
5. How far is it justifiable to enhance the risk level of lending institutions?
6. How long our micro, small, and limited income earning depositors would be exploited in terms of poor return on their deposits?
7. Whose interest (in benefit or wellbeing sense), public or private interest, is preferred?
8. Do the preconditions for effective operation of free market mechanism exist in the financial sector of Bangladesh?

Present discussion will now centre round the above questions. There may  be, as we are all aware,  three options  for determining  bank interest rates ( mainly for  deposit and lending): (a) Free market mechanism, (b) Administered or Directed  Pricing,  and (c) Mixture of both market and directed mechanism. The structure of 6  to 9 per cent  interest rates  had been a  type  of administered pricing,  and recently, the  government  declared  it to have been ineffective  since July 1, 2023. In lieu of 6-9 per cent interest caps, the government has introduced a reference rate for fixing the new lending rate. Is it a wholly market-driven method of interest rate setting? Obviously, it is not so although Bangladesh Bank (BB) claims (Monetary Policy Statement July 2023-December 2023, p.30) to have introduced a market-driven reference rate.

SMART is, in fact, the acronym of Six-Month Moving Average Rate of Treasury Bill and regarded as a reference rate for setting the final lending rate. Bangladesh Bank will announce SMART on the first working day of each month through its website. The discount rate on Treasury Bills will fluctuate whenever auctions are to take place. Accordingly, SMART may vary each month, resulting in a flexible lending rate. As per BB instruction, banks would generally set the final lending rate using the formula: SMART  plus 3 per cent, while SMART plus 5 per cent is to be  followed  by NBFIs (non bank financial institutions).

Ignored are the issues such as deposit interest rate and banks' spread level. It is still uncertain as regards  which one  of the three options of setting  interest rate would be ultimately applied to  deposits supplied to the extent of about 60 per cent of total deposits  by   micro, small, and  limited-income savers. As SMART is linked to the securities market, its yield-volatility is 100 per cent certain. Deposit interest rates need to be raised, but they are destined to vary with SMART. Rather, it may spark uneven competition and manipulations that would ultimately penalise the good banks and FIs as well as the depositors. Central bank's decisionmaking on the new lending rate fixation formula seems not based on  any analytical study.

Do the preconditions for operation of free market exist in our country? Depositors belonging to micro, small, and limited income groups, in particular, do not have any association or forum to enforce bargaining power to protect their rights in the so called free market. Attacked by the stings of  longstanding inflation, they have been losing because of negative  returns ( in real value) while BB's mission statement claims to  ensure  fair return to depositors.

Government's domestic borrowing report (published by BB) suggests that almost 100 per cent of government securities ( G-sec) including T-Bills are owned by  institutional buyers  among which BB holds only about  14 percent. Besides this, the government procures fund from T-Bills  to the extent of not more than 20 per cent  of total domestic borrowing. Hence it is obvious that BB as an agent of government funding drive would not be interested enough to raise fund from short term source like T-Bills.

As issuer BB cannot not allow a big discount while outside banks and FIs would press for a big discount to have a profitable investment. But buyers are obliged to buy T Bills at a lower discount in order to meet SLR and collateral needs to get fund in the Repo market. In this low discount transaction, yield on T-bill would considerably decrease. Contrarily, in case of higher demand for short term demand for fund from T-Bills, discount has to be raised and T-bill rate would  go up a lot. Very frequent changes in the interest rate fixation and re-fixation would lead to a disastrous situation in the market. Will it bring stability in the financial sector?

Any good policy is the outcome of good governance. Hierarchically, the corporate governance for the banks and NBFIs has two tiers-the upper one lies with the central bank, and the lower one lies with the individual bank and financial institution. The prevailing approach to the process of decision making on major policies cannot sound effective, pragmatic and appropriate in the context of sharp competition, deregulation, and unavoidable stakeholders' expectations. The degree of decentralisation, emphasis upon practitioners' views and experiences, transparency (including public disclosure of core decisions) in  deciding on vital issues  are some of the  most important factors determining the quality of good corporate  governance. How far have we progressed towards good governance in the financial sector?

Haradhan Sarker, PhD,  ex-Financial Analyst, Sonali Bank & Professor of Management (Rtd.).
sarkerh1958@gmail.com