The Financial Express

The challenge of executing single-digit interest rates

Jonaed | Published: February 03, 2020 21:14:52 | Updated: February 13, 2020 20:40:38

The challenge of executing single-digit interest rates

Lending rate is one of the main determinants of private investment, which contributes to gross domestic product (GDP). The share of private investment in Bangladesh's GDP was 23.4 per cent in 2018-19 fiscal year and is projected to be 24.2 per cent in 2019-20, according to Bangladesh Bureau of Statistics.

To boost private investment and create new jobs through industrialisation the government has decided to put down lending rate to 9.0 per cent from existing 12-14 per cent in all sectors except credit cards, and deposit rate to 6.0 per cent from current rate of 8-10 per cent on all types of deposits.

The Finance Minister, AHM Mustafa Kamal, hopes to implement the decision from April, 2020.

If the government can execute the decision the borrowers will be gleeful since low lending rate brings down cost of doing business that eventually encourages more private investment. Growth in private investment would spur higher GDP and create more jobs, a key target of the government.

There are two other key stakeholders involved with the decision: the depositors and the banks. The challenges of implementation come mostly from these stakeholders. The depositor will certainly be unhappy with the move as their savings will now generate smaller returns.

Moreover, the current inflation rate of around 6.0 per cent (BBS, 2019), and fluctuating inflation will discourage them to keep deposit with banks. A 6.0 per cent deposit rate with a 6.0 per cent expected inflation rate actually leaves no real gains of depositing, since the real returns equals the interest rate (nominal) minus the expected inflation rate (Irving Fisher, 1930). This kind of situation may lead to a decrease in loanable funds.

This move may also bring tribulation for banks. Covering the cost of deposit, regulatory compliances, overhead costs and risk premium of various risk factors including non-performing loans (NPLs), the 9.0 per cent lending rate hardly leaves margin for the banks to make profit.

For example, if a bank receives a deposit of Tk100 at a 6.0 per cent rate, it would be able to lend Tk85 only, since the loan-deposit ratio is 85 per cent for regular banks. By lending Tk85, at first, the bank has to pay Tk6.0, which is 7.06 per cent of Tk85 to the depositor. There overhead cost, cost of risks, and a 6.0 per cent inflation rate eventually affect the banks' profit margin.

The move may also disrupt market mechanism for funds since banks will not be allowed to collect deposit at rates beyond 6.0 per cent and depositors' reduced interest in depositing money with banks may cause decline in supply of loanable funds.

Simultaneously, due to lending rate cut, demand for loanable fund will significantly increase. The situation may give birth to a significant gap between demand and supply of loanable funds. This mismatch will intensify liquidity crisis of banks, keeping pressure for increasing the rates. Some banks may face higher challenges in such a situation.

However, the government plans to keep 50 per cent of its deposits with private banks, which are currently deposited with state banks to tackle any liquidity crisis and create a balance between demand and supply of loanable funds. But the question arises: Will it be enough to bridge the gap.

Presumably, it would be a tough task for the government to implement the decision of single-digit interest rates. If it wants to make the decision a reality, more initiatives have to follow to help the banks execute the decision.

Reducing cash-reserve ratio and the rate at which the central bank lends money to banks may be an effective move. Moreover, taking adequate steps to address the NPL crisis would be a great weapon to convince the banks to implement the decision.

However, if the government somehow creates pressure or can convince the banks to implement the decision, it will be interesting to see how the targeted rates are made sustainable.

 Jonaed is a Research Associate at South Asian Network of Economic Modelling (SANEM).



Share if you like