The enigma of lending cap

The other day a leading and vocal economist, while taking part in a discussion held recently with the members of the Newspaper Owners Association of Bangladesh (NOAB), blamed the 'noy-chhoi' (9-6) rates of interest for destabilising the country's banking sector. The rate cap also created lots of distortions in the economy, he felt
The central bank and the scheduled banks had no plausible reasons to be interested in the cheap interest rates either for lending or taking deposits. The truth is, those were imposed from the above allegedly at the insistence of some top corporate clients. The latter, using various platforms of private sector businesses, convinced the government high-ups with the argument that they needed cheap money to overcome the COVID-19 pandemic fallout and help boost private investment. The rates came into effect well before the start of the Russo-Ukraine war.
The centrally dictated rates cap did more damage than good to both banking sector and economy. For instance, fixing the deposit rates at a low level forced many existing depositors to withdraw their deposits and discouraged many potential depositors from coming to banks. However, such a trend did not create any notable problems, primarily because of poor demand for funds during the latter part of the pandemic. A section of borrowers, including some delinquent ones, however, using their links with the influential quarters took cheap loans and defaulted on repayment. Rescheduling facilities offered under different pretexts kept those borrowers afloat. The banks became victims of all these exercises as the size of their classified loans continued to bulge. Profits of banks also took a plunge.
The statistics on classified loans that the central bank makes available at the end of every quarter do not give the true picture of the non-performing loans. Newspapers, while reporting on NPL, make it a point that the size of classified loans would be bigger if all rescheduled and written-off loans were taken into account. There could be some other grey areas in the process of counting NPL.
Did the lower lending rate help private investment? Belying all expectations, private investment continued to be stagnant in recent years. The private investment to gross domestic product (GDP) ratio hovered between 23.5 per cent and 24.5 per cent during the last four financial years. The ratio was the lowest level (23.64 per cent) in the FY 2022-23. Thus, the dictated lending rate fixed at the lowest level ever caused more harm than good to the cause of the banks. Economists did not like the idea of such dictated rates, yet the central bank kept those in place.
However, coming under pressure from a multilateral lender, the central bank lifted the 9-6 rate cap some months back. However, banks are not free to fix market-based lending and deposit rates. The Bangladesh Bank has introduced a reference rate known as SMART (six-month moving average rate of treasuries) through which banks are fixing the lending rate. The SMART itself is a cap. Given the tight liquidity situation, banks would have pushed lending and deposit rates further up had they not been bound by SMART conditions. This would have helped the central bank to rein in the runaway inflation.

[email protected]