Banking shenanigans have grabbed headlines recently for good reasons. Throughout history people have heaped scorn on money-lenders. Good governance is a must if institutions, especially the ones which sit at the commanding heights of the economy, are to be nourished. When headstrong individuals play god, reasoning and best practices are trashed. This tragedy is enacted in Bangladesh time and time again, with no end in sight.
The Finance Minister has directed that the cash reserve ratio (CRR) be reduced marginally. The thinking goes, this step will ripple through the economy by creating loans. However, this fallacy must be quashed.
Cash is an asset. When banks park cash with the central bank, it is formally known as reserve. In the central bank's books, it is a liability. CRR is an asset for the commercial bank, with shackles on to be sure. Loans are book entries; they do not depend on how much cash banks hold, either in their vaults or with Bangladesh Bank.
The United Kingdom has scrapped this practice, perhaps because the Bank of England (BoE) realised CRR's inefficacy as an instrument of monetary policy. When making loans, a key consideration is a bank's deposit to advance ratio. Other considerations are: prevailing interest rates & spread; credit risk; general economic & business conditions, loan losses which tend to push up the cost of funds, and competition.
The lending rates that banks charge depend on, firstly, the cost of fund and, secondly, on explicit directions from the central bank, an example being export credit. Some banks do hike up their effective rates by charging disbursement fees. The cost of funding is derived by the weighted average cost of deposits. The cost of deposits refers to interest paid to customers. Our presumption is that the current interest (deposit) rates (on term deposits) are a reflection of inflation and our economic growth rate.
Credit risk is a very important criterion, especially in the context of the default culture that has pervaded Bangladesh. In effect, bad borrowers are driving out good ones.
When loans are repaid, deposits come down system-wide, tamping down total money supply. A reduction in money supply reduces economic activity and, by extension, overheating. Let us think of it as a 'coolant'. But this natural banking mechanism has been rendered ineffective by the captains of our industry.
General economic conditions are gagged by a slew of leading and lagging indicators, for example private investment, inflation and business confidence. These weathervanes have been in existence in advanced countries for some time. Low-income countries have been slow to catch on. This goes to show that Bangladesh should do its utmost to collect data and turn these into actionable information. Analysts and decision-makers yearn to be well-informed with quality data, indicators, etc. Lending takes off when the economy looks up and vice versa.
Provisioning for bad loans is expensed in banks' income statement, not actual write-offs. Provisioning is done on a sliding scale, depending on how bad a loan is. When banks' incomes slide in tandem with bad loans, they get cautious and lending stalls. This acts a brake on the money supply.
With so many banks around, one bank would tend to elbow out the other in the race to book business. Individual banks will find fewer opportunities in the face of stiff competition. Perhaps banks are lowering their standards (guards?) as a result.
We are not so sure about what good will come about as a result of the decision allowing government deposits in private banks. This may, in fact, open up instances of kickbacks. With windfall deposits literally knocking at the doors of private banks, the temptation will be to go on a lending spree. Will that make a bad situation worse? This sort of re-shuffling of the deck will have little, if at all, system-wide impact. The loan to advance ratio will be out of whack for the banks, bleeding the deposits.
Going by media reports, the crux of the problem now is one of liquidity. Liquidity problems arise when a corporate body fails to meet its current liabilities as and when they fall due. The remedy lies in judiciously managing assets - in other words, the asset mix. We also note that private banks have diverted assets into opulent buildings and plush sofas.
The starting point of liquidity management is asset-liability matching and associated maturity ladder. That over, adequate liquid assets should be parked in the form of cash in till and with Bangladesh Bank, treasury bills, call money, and cash with other banks to cope with customer withdrawals as well as repay near-term liabilities. This important matter should be taken to heart, especially when loans spike. Additional loans translate into more deposits in the same bank, although not correspondingly.
Raihan Amin is Part-time Faculty, United International University.
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