Interest rate cap: Its implications

Many private entrepreneurs have long been demanding lower interest rate to reduce cost of doing business. The government held a number of discussion sessions with the private sector on the issue. At one stage, the Bangladesh Association of Banks (BAB) came out with an announcement to reduce interest rates by themselves. There were debates over the roles of the Bangladesh Bank and the BAB in interest-rate lowering.

The question was repeatedly raised as to why interest rate cannot be lowered. People are generally aware of reasons for high interest rate, with one being high amount of non-performing loan (NPL) which is about 12 per cent of overall loans. Still some argue because of a number of policies relating to loan provisioning, the NPL figure has apparently come down. Huge management cost, inefficiency, non-digitisation and some other factors are also responsible for high interest rate, burden of which has to be borne by the private sector.

Against this backdrop, the Bangladesh Bank issued a circular imposing a ceiling on interest rate for all schedule banks from April 01, 2020. Now the lending rate for all sectors will be 9.0 per cent maximum except credit cards and the deposit rate will be 6.0 per cent for all types of deposits.

It is assumed that the new single-digit interest rate will be a boost for the private sector growth by having more investment and creating new jobs, a critical need of the country at the moment. Moreover, borrowers will highly benefit from this interest rate as it would gradually decrease their cost of doing business.

The Bangladesh Bank circular of February 24 also mentioned that in case anybody still fails to pay the instalments on a regular basis, default instalment and working capital/investment/additional profit will be penalised with additional 2.0 per cent interest rate. Islamic banks are also required to maintain the policy. There was a mixed reaction to the policy. Some are apprehensive and said it goes against the dynamics of the market which has been determined by demand and supply; so the market intervention might give different results instead of supporting the private sector.

Non-bank financial institutions (NBFI), which contributed about 16 per cent of the total industrial loan in 2018-19, have been kept outside the purview of the circular, but as their main source of funding is money from banks, the announced policy could be an issue for them in increasing cost of funds. Private sector banks contributed about 76.29 per cent while state-owned commercial banks 3.23 per cent, and foreign banks 3.43 per cent and specialised banks 1.08 per cent of industrial loan during the period.

According to NBFIs, since there are limited alternatives in the market, for funding arrangement they may face problems; they do their business in the niche market, so interest rates for both deposit and lending are a bit high. 

Other funding alternatives are also limited. bond market, for example, could be a good source, but limited and undeveloped bond market cannot give them enough hope. There are apprehensions that as deposit rate will come down, depositors will also have limited alternatives. The government has streamlined the savings schemes in order to reduce anomalies. So there is a fear that the surplus money people have in their hands may go to the informal sector thus creating another concern in the market.

SMALL ENTREPRENEURS: A major frightening issue is that small entrepreneurs may face more problems as banks are usually not willing to extend funds to them on the plea of the so-called heavy supervision cost. The central bank's annual report shows that in the year 2017-18 while large industries received  Tk 55.2 billion (552  crore) CMSME (cottage, micro, small and medium enterprises) received only Tk 15.6 billion (156 crore). This gap may increase further as the large entrepreneurs' demand will increase because of lower interest rate and after meeting their need, the surplus  credit to be disbursed for SMEs (small and medium enrerprsies) will naturally be a smaller amount. Contribution of SMEs (small and medium enterprises) is no doubt significant and the government's policies should be to encourage more SMEs, for which finance is the number one challenge,  especially in the rural areas. Lowering of interst may prompt the scheduled private banks to change policies towards selecting their clients.

STATE-OWNED BANKS: State-owned banks have already implemented the single-digit interest rate. It was observed in a discussion session held by a Bangla daily that these banks were better prepared as the issues were being discussed for about one and half years. While overall growth of banking deposit hovered around 10 per cent or so, state-owned Agrani Bank saw 17 per cent deposit growth in 2018  from only 7.0 per cent the previoius year. Combined deposit growth of all state-owned banks increased despite reduction in interest rate. Their loan disbursement rate for SMEs and others also rose in 2018 and 2019.

CREDIT RATIONING: It is apprehended that because of fixed ceiling interest rate and the private sector's hunger for credit, there may be credit rationing, meaning not all the entrepreneurs would get required loans while the most uncomfortable situation  may arise for the SMEs.

Since deposit is most likely to go down due to lower rate -- 6.0 per cent -- the banks might have to address these gaps by reducing their fund management cost, raising level of efficiency and introducing digital technology. Our banks are also burdened with huge pool of manpower while in the developed countries technology is working as a substitute. In some countries banks also outsource their services.

IMPACT OF LOWER INTEREST RATE: Depositors are set to face the impact of lower interest rate. There may be serious implications of issues such as lowering interest rates for the informal sectors. So, the ceiling policy should not be implemented in an isolated manner. Also coronavirus is likely to affect our economy due to its impacts on the global economy. The implementation of the single-digit rates might not be smooth in such a situation.

Ferdaus Ara Begum is CEO at BUILD, a public-private dialogue platform, supported by DCCI, MCCI and CCCI.

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