Behind the rising rate of interest

Banks in recent times were not very happy with their profit. In order to sustain profit growth, many of the banks violated Bangladesh Bank's (BB) asset management guideline issued on March 07, 2016. The banks can issue advance up to 85 per cent against their deposits in case of conventional banking and up to 90 per cent against their deposits in case of Islamic banking. The violations have pushed such ratio of many banks to the range of 90-92 per cent - well above the prudential norm of below 85 per cent.
BB in its contractionary monetary policy statement (MPS) for the second half of FY 2017-18 revised the ceiling for advance-to-deposit ratio (ADR) to 83.5 per cent, which is down by 1.5 percentage points for conventional banking. For Islamic banks, it has been cut by 1.0 percentage point to 89 per cent. On January 30, the day immediately after announcement of the MPS, the central bank issued a circular in this regard. Banks were given time up to June 30, 2018 to bring down ADR to the revised level.
On February 20, BB came up with a second circular extending the last date for rolling back ADR to December 31, 2018 from June 30, 2018 after realising the impact of such a sudden strict policy. However, there is a common understanding that such irregularity by banks is not merely a recent phenomenon. BB's inaction over the period of last few years is rather questionable. Banks used to prefer indirect investment in the share market for safe return rather than issuing credit for manufacturing sector - particularly in the SMEs. They also tried hurriedly to pull back some investment from the market and triggered fall in the share market.
It was also well-anticipated that BB would get tough against the offenders and require them to roll back ADR within a given timeframe. Since the advances already made cannot be readily called back, the only way the ADR can be lowered is by raising the volume of deposit. Banks became aggressive in increasing their deposit and lending rate. Some banks already increased the deposit rate up to 9.5 per cent, which was 3-6 per cent few months back. Meanwhile, some banks already increased the lending rate up to 15 per cent.
Moreover, the liquidity problem was in the making for the last several years as the banking system was experiencing a declining growth in its deposit rate. It was primarily due to the diversion of savings to the national savings instruments/bonds, which were offering interest rates well above the market rates. The impact was not felt earlier until recent time as the banks had surplus liquidity.
A major portion of those surplus liquidity has already been invested in government-approved securities and BB bills as risk-free investment by the banks. Savings certificate sales target was set at Tk 601.50 billion for the current fiscal (2017-18). The government borrowings through sales of savings tools are the most expensive means of internal borrowing as the government has to allocate a huge chunk of money every year from revenue budget for payment of interest.
From the financial point of view, it is clear that the rise in sales of savings tools will push up the government's expenditure on interest payment depriving the development needs of the country. If the current trend of sales continues, the target would surpass setting a new record, officials said. Sales of saving certificates hit a record high of Tk 751 billion in the last fiscal (2016-17) when compared to previous fiscal's Tk 537 billion - thereby posting a 40 per cent year-on-year increase.
The surplus liquidity evaporated with continuous decline in growth of bank deposits and eventually it declined to only 11 per cent in the fiscal 2016-17 and at the same time the growth in private sector lending accelerated to 18-19 per cent. The liquidity problem was also accentuated by the increasing burden of non-performing loans (NPLs). Due to this excess lending over deposit with the revised lending ratio in MPS, some banks are on the verge of facing liquid crisis and hence scrambling for deposits - thereby pushing up the deposit rates.
It is well-established in economic theory that there cannot be two prices or rates of return for the same/similar financial instruments in a unified financial system. Since government-administered savings certificate interest rates were not allowed to come down to the levels of market determined rates, the market rates had to move up towards the savings certificate rates to ensure market equilibrium. The interest rate offered by the government to savings instruments naturally serves as anchor for deposit rates in the banking system. Sales of savings tools will continue to rise this fiscal year unless the government cuts the interest rates.
The international trade account deposit has put another pressure on liquidity. The corresponding trade account deficit was $8.6 billion, almost double the level of deficit from a year earlier. BB has resumed the support in recent months through selling the US currency to the banks directly to keep the foreign-exchange market stable. This situation is creating imbalance in the foreign exchange market - thereby forcing the BB to sell dollars in the interbank foreign exchange market to stabilise the exchange rate.
The external current account deficit has surged to $4.76 billion in the first half of fiscal 2017-18, compared to a deficit of $0.54 billion only a year earlier. As a result, remittance is showing an increasing trend. On the other hand, banks are losing further lendable fund as they have to buy foreign currency from BB. Because, domestic currency is going back to BB in such case. Meanwhile, bankers said private sector credit growth swelled further in January due to higher trade financing for settling the import-payment obligations particularly for food grains, fuel oils and capital machinery.
The latest BB data showed the growth in private sector credit reached 18.36 per cent in January 2018 on a year-on-year basis from 18.10 per cent only a month before. The deposit growth had been on a slide, falling from 13.13 per cent on December 31, 2016 to 10.94 per cent on June 30, 2017 and 10.60 per cent as on December 31. On the other hand, credits climbed to 18.10 per cent as on December 31 from 15.98 per cent on June 30 of last calendar year. It was 15.32 per cent as on December 31, 2016. Besides, around Tk 138 billion entered the BB vault in exchange for US$1.68 billion sold by the central bank to the banks during a period from July 01 to March 20 this year, said a BB source.
The liquidity crunch that has hit the private sector has its roots in the Farmers Bank debacle. When the news hit the market that Farmers Bank was in deep turmoil, depositors, both individual and institutional, tried to cash out, but the money was simply not there. Again, this debacle has had a chain effect on other banks and lots of depositors have withdrawn their deposits and placed them in savings instruments, which are considered to be "safer" investment. Today, we are faced with a situation where banks are now scrambling for deposits and in this race there is a competition to lure back depositors even offering higher deposit rates. The downside of this of course is that credit interests are also being raised to cover the cost of the banks for giving depositors higher returns on their deposits.
It is understood that the central bank will not allow any expansionary policy in the coming months as a general election is approaching and scheduled to be held in the later part of this calendar year. The policy of lowering the ADR across the board has suddenly created a surge in deposit requirements - thereby pushing the interest rate up and shaking down confidence in the capital market. The widely-criticised high rates of return on savings instruments are silently affecting the savings and lending schemes of the banks. It is also an unnecessary burden on the budgetary allocation as higher interest is reducing the development budget.

MS Siddiqui is a Legal Economist. [email protected]