Tug of war over banks’ lending rate

August 12, 2009

Shamsul Huq Zahid — Banks’ lending rates, for quite sometime, have been caught in a tug of war despite the fact that banks should be free to fix their individual lending rates taking into cognizance a host of factors.

Following pressure from the government policymakers and the central bank, the commercial banks only recently have, rather unwillingly, reduced their lending rates, the maximum one being fixed at 13 per cent.

However, the interest cap is applicable only in case of loans to the real sectors of the economy and the banks are still enjoying freedom to fix their lending rates on consumer loans, which is as high as 16 per cent.

Yet the central bank governor is not happy with the lending rate cut by banks. He wants the latter to bring the rates down to single digit in view of the recent 2.5 per cent cut in tax on profit of the banks and non-banking financial institutions.

Speaking at the mid-year business conference of the this week in Dhaka, the governor pleaded for lending rate cut to help boost the sagging private sector investment in the country.

The pleading made by the Bangladesh Bank governor for lending rate cut is not entirely a new proposition. The central bank governors of many other countries, including those of our neighbours have been trying hard to convince the banks to cut their lending rates to help their economies hit by the ongoing global recession.

Governor of the Reserve Bank of India (RBI) Dr. Subbarao late last month told the chief executive officers of some major Indian banks that there were scopes for reduction in lending rates in India to 9.5 per cent even without any revision in policy rates. The average lending rate in India is around 10.5 per cent. But the Indian banks are not responding to the RBI governor’s rate-cut plea.

In the case of banks in Bangladesh, will it be feasible, under the given circumstances, for banks to bring down the lending rate to single digit?

The issues such as deposit rates, banks’ interest rate spread, investment trend, liquidity situation in the banking sector, inflation and banks’ profitability are all relevant to the issue of lending rates.

If the maximum lending rate is brought down to single digit, say 9.0 per cent, the average rate of deposit would come down to 4.0 per cent, leaving a 5.0 per cent spread for banks.

With inflation hovering now over 6.0 per cent (it might go up even further in the next few months), will such a low deposit rate be justified? What will then be an effective real deposit rate?

The presence of a substantial amount of idle money, an estimated Tk. 347 billion, in the banking system might be one reason behind the proposal for further cut in lending rates. But lowering of deposit rates further might trigger a reverse trend. The depositors would be left with no option but to take out their fund from banks and invest the same in some other places, including the high-interest bearing government savings instruments. Some may even move to the stock market where the mismatch between demand and supply is likely to lead to a new wave of speculative trading. Or the savers’ fund may partly move to an overheated real estate market where prices will continue to move sky-high.

On their part, businesses would always prefer lower lending rates since the same help them keep their cost of doing business at a low level. But lower lending rates do not always help boost investment. There are other factors, including supply of gas and power, law and order and demand for goods and services in an economy, that do influence investment decisions. Credit to private sector grew at a fast pace between 2004 and 2006 when the banks offered high interest bearing loans.

Under such circumstances, it would be prudent to undertake, first of all, a review of the situation — whether the recent cut in lending rates has left any positive impact on the investment situation and to what extent?

There is also no denying here that lower lending rates do benefit the existing producers of goods and services. But such benefits are hardly shared with the consumers. Most businesses are found to maximize their own profits taking advantage of the lending rate cuts. This is an issue that cannot be ignored by all concerned.

However, the issues mentioned above do not anyway undermine the importance of further lowering lending rates. Banks can surely cut their lending rates without hurting the interests of their own and also of depositors. The goals can be largely achieved if the banks do exercise prudence in their administrative as well as ‘other’ expenditures.

Private banks, in some cases, are reported to be pushing up their administrative costs, — and that too not necessarily always with any solid logic — by hiring senior bankers at inflated compensation packages. None would contest here that salaries given to bankers in the state-owned banks are dismally low. But at the same time, pay and allowances offered to high officials of some private banks are, in many cases, on the much higher side than what is warranted by circumstances in the Bangladesh context.

Another area which banks do need to focus their attention is a critical review of their operational expenditures relating to opening of new branches. High costs incurred on interior decoration of branches, particularly in posh residential areas and business centers, can thus be cut down substantially in a good number of cases. Then again, reports in the media do also suggest there are open and hidden expenditures on the sponsor directors of some private banks. Being the regulator, the central bank does need to look closely into the financial statements of the banks and also to provide guidelines that are enforceable about bringing down the operational costs of banks without impairing their efficiency as well as productivity of their employees at different levels.

Tug of war over banks’ lending rate

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