Mourad Ullah Bhuiyan |
02 April 2022 10:36:30
April 2, 2022 10:38:25 a.m.
Until 1990, Bangladesh’s lending rate structure was administered by a mechanism established by the government. Thus, the interest rates on deposits and loans were not changed simultaneously with the movement of inflation. Moreover, the government has attempted to give incentives to depositors by raising the deposit rate, while lowering the lending rate for investor interest at the same time. However, after a financial sector reform program launched in 1990, a new interest rate policy was introduced based on a market-oriented interest rate system. Under this policy, banks were allowed to set their interest rates for deposits and loans within a range set by the Bangladesh Bank (BB) for different sectors excluding agriculture, small and medium-sized enterprises (SMEs) and export sectors. However, the band was removed by allowing banks to set their own interest rates from February 1997.
As Bangladesh strives to become the three fastest growing economies in the world by the next decade, according to the 7th Five Year Plan (7FYP), investments must be increased. Bangladesh’s gross domestic product (GDP) grew at an average rate of 6.1% with an average gross domestic investment as a percentage of GDP of 27.2% in FY11 to FY15. The 7FYP targets average annual economic growth of 8.25% in FY20 and an increase in average gross domestic investment as a percentage of GDP from 28.9% in FY15 to approximately 34.4% in FY20. Due to the Covid-19 pandemic, GDP grew only 5.24% in FY20, where average gross domestic investment as a percentage of GDP was of 31.75%. (According to the revised GDP estimate based on the new base year (2015-2016), the GDP growth rate stood at 3.45% in FY20 and the investment/investment ratio GDP at 31.31%.) Furthermore, the data shows that credit growth has not increased much due to high lending rate over the past decade with few exceptions from FY04 to 2004. FY14. As a result, economic growth had been below potential as investors did not feel encouraged to invest due to the high cost of borrowing. In view of this situation, Bangladesh Bank has issued a circular dated February 24, 2020 that the interest rate on loans cannot be higher than 9% for advances or investments, except credit card, from April 1, 2020.
It is important to consider what factors play a determining role for the loan rate in Bangladesh. The setting of the loan rate for the Bangladesh banking sector depends on the cost of funds, the demand and the competitor’s interest rate on the deposit. Deposits in different banks are their main source of loanable funds. To attract these deposits, banks must be generous to depositors by offering higher deposit rates and faster service. Therefore, banks could adjust the lending rate to raise it more quickly and instantly if interest rates on government bonds and other financial securities rise.
However, banks may not automatically reduce their lending rates immediately based on market rates. Therefore, it becomes costly for customers to switch to another lender after developing certain business contacts, as asymmetric information exists between banks and their customers.
In Bangladesh, interest on non-bank savings certificates such as National Savings Department (NSD) certificates imposes a fixed interest rate of 11.28% (effective from 23.05.15) on savings. As a result, it is very difficult for banks to attract deposits with a deposit rate above 6% (it was 5.06% in July FY20 and gradually decreased to 4.36% in April FY 21) , which appears to be low considering that it only responds to the current rate of inflation. The lack of loanable funds in program banks will therefore tend to drive up the lending rate.
As mentioned above, regular banks in Bangladesh have the right to set their lending rates according to their own business interests as a result of BRPD circulars, government bond and bill auctions. If the interest rates of government bonds and bills increase, the lending rate of commercial banks will also increase. Therefore, if commercial banks set relatively higher interest rates on loans, there will be the possibility of higher risk of non-performing loans (NPLs). Moreover, in most cases, these PNPs pose a double problem of adverse selection and moral hazard, which gives rise to contradictory information when the borrower has more information than the lender.
Considering the importance of determining the lending rate, Rouf and Chowdhury (2015) analyzed the factors responsible for the high lending rate in Bangladesh and found that the deposit rate, excess reserves, price index rate (CPI) and the policy rate significantly affect commercial bank lending. rate. However, they did not analyze the dynamic impact (short and long term) of the determinants on the borrowing rate.
This article attempts to find the determinants of commercial bank lending rate in Bangladesh considering the dynamic impact (short and long term). Therefore, the objective of the study is to determine the magnitude or related factors that affect the interest rate on loans in Bangladesh. The complete working document with the econometric analyzes is available on the central bank’s website (www.bb.org.bd). This article briefly presents the results and conclusions of the article.
EMPIRICAL EVIDENCE OF INTEREST RATE DETERMINANTS: Theoretically, the interest rate on loans is roughly determined by five approaches such as (i) classical theory of interest rate determination or real theory of interest rate determination of interest rates, (ii) the neoclassical theory of the determination of interest rates or Theory of loanable funds for the determination of interest rates, (iii) Determination of interest rates by the Keynesian theory of preference for liquidity, (iv) New Keynesian Theory of Interest Rate Determination or Modern Theory of Interest Rate Determination, and (v) Fisher Determination of Interest Rates Model Approach.
Macroeconomic indicators such as economic growth, inflation and interest rates reflect the degree of financial stability of a country. According to the Keynesian income identity, investment is one of the key components of GDP. But the investment is inversely proportional to the interest rate on the loans. If a country has an unusual lending rate, the investment will be halted. Therefore, it is important to keep the loan rate in a suitable state, that is, neither too high nor too low. Due to the persistence of a high lending rate, Bangladesh Bank sets an interest rate cap on lending of 9% from April 1, 2020 to narrow the interest rate gap to encourage investment activities.
RESULTS AND CONCLUSION: This study found that the deposit rate and the ratio of non-performing loans to total loans have an impact in determining the lending rate in Bangladesh in both short and long term after controlling for the ratio money supply to GDP and considered data from fiscal year 1997-1998 to 2018-19. For example, if the deposit rate increases by 1 percentage point, the lending rate will increase by 1.32 percentage points in the long run, which is statistically significant at the 1.0% significance level. If the ratio of net nonperforming loans to total loans increases by 1.0%, the lending rate will increase by 0.21 percentage points in the long term with a significance level of 10%. Moreover, the profitability ratio has a long-term impact in determining loan rates in Bangladesh. Also, the long-term and short-term deposit rate have an impact on the lending rate, while the ratio of non-performing loans to total loans only has a long-term effect. Therefore, the deposit rate, profitability ratio and the ratio of net non-performing loans to total loans are the determinants of the lending rate of commercial banks in Bangladesh.
POLICY RECOMMENDATIONS: Since higher rate of return is one of the factors responsible for high lending rate, bank management should consider how to reduce profitability for the welfare of the society. It is imperative to strengthen bank governance to improve asset quality, as the high stock of non-performing loans is a concern in the banking sector. The high ratio of net nonperforming loans to total loans reflects financial inefficiency, which should be improved by strengthening financial intermediaries.
As the ratio of net nonperforming loans to total loans increases by 1 percentage point, the lending rate will increase by 0.0614 percentage points in the long run. Therefore, a stable and capable financial institution is necessary for higher investment. In this regard, the Credit Information Bureau (CIB) should be improved to help banks better assess the creditworthiness of borrowers. The volume of investments should be increased in the quality of loans. Additionally, it is critical to empower the bank to sue for bad debt or bad debt collections, foreclosures without injecting a loan default stay order from the Supreme Court.
The total volume of savings should be increased by increasing the savings rate to stimulate the investment rate.
In the analysis, the deposit rate of banks is found to have an impact on the lending rate given the two data samples (FY98 to FY19 and FY98 to FY20). The reason behind the impact is that there is no cap on the deposition rate in the two samples, when analyzing the data. However, after the lending rate cap introduced by the government in February 2020 with effect from 1 April 2020, all variables except the deposit rate found no impact on the lending rate, apparently the capping of loans has an impact on the market channel.
Murad Ullah Bhuiyan is Co-Head of the Chief Economist Unit of Bangladesh Bank.