Will the contractionary monetary policy deliver?
Saturday, 11 August 2007
Ahmed Showkat Masud
THE latest decision of the Bangladesh Bank to increase the required reserve ratio and maintain it up to December 2007 demands a more cautious handling of asset-liability management by the commercial banks. Such banks cannot control the market-based interest rate. It is largely influenced by the central bank's monetary policy.
Demand for, and supply of, money determine the interest rate. Now banks are holding excess liquidity. Since the anti-corruption drive is going on, the matters relating to under-invoicing and over-invoicing are being monitored vigorously and some punitive measures have been taken by the government against some influential businessmen; the business community is still in a confusing state and suffers from lack of confidence due to a situation of panic that prevails in the country on real or perceived grounds.
They are not fully active yet being back in the business, despite government's repeated assurance about businessmen, not being involved in gross dishonest practices, will not be harassed. But a number of businessmen, particularly those who are involved in export and import trade, had been involved in over-invoicing and under-invoicing. Here exceptions are not many. However, the exporters are running their operations in the business-as-usual manner. The dominance of readymade garment (RMG) sector is one of the causes behind it. They are doing business in a more competitive global market. If any buyer switches over to another country, then the existence of the related exporter will be at stake.
But, in case of importers, the situation still remains different. Repeated government assurances, incentives like allowing waivers of duties in case of some essential consumer goods etc., are yet to have any positive impact.
The import business remains, on the whole, less buoyant, whatever the figures about opening of letters of credit may suggest. Despite this, the commercial banks will have to face the growing demand for money in the upcoming months in order to meet the demand for normal credit flow to the manufacturing as well as service sectors. Besides, they will have to make payment against LCs opened or to be opened for importing consumer items-related to the demand pattern during the holy month of Ramadan. The common people will require more money to spend for the month of Ramadan. Most of them, particularly those belonging to the middle class, require more money to meet the expenses on the occasion of Eid-ul-Fitr, the largest religious festival in the country. Under this situation, the banks holding excess liquidity will have to keep the fund with them to meet the customers' demand.
The country is now experiencing a severe flood almost all over it. Roads, bridges, dwelling houses etc., have been destroyed/damaged or will come under further damage. To face the post-flood situation, the government will be in need of a huge fund to meet the expenses for repairs of the damaged infrastructure. Agricultural sector will also be in need of fund. Shops, manufacturing units of flood-affected areas etc., will approach the banks for borrowing money. That is, the surplus money that the banks are holding will be needed to meet the demands for the same.
Since the government has adopted a more contractionary monetary policy, the bankers will have to face the situation in view of the possibility of their losses due to upward movements of interest rates. The bankers will have to calculate the duration of their respective banks' assets and liabilities. It is a value- and time-weighted measure of maturity that considers the timing of all cash inflows from earning assets and cash outflows associated with the liabilities. Banks receive interest earnings from its loans and securities and make payments of interest to the depositors.
A rise in market rates of interest will lead to a decline in the value of banks' fixed-rates. When the interest rate goes up, banks' asset value tends to decline, particularly for those assets having longer time for maturity. Longer duration maturity assets will decline in net worth when interest rates rise. Short-term loans will have less negative impact on their net worth. For example, if a loan which was disbursed one year back at the rate of interest at 14%, the borrower will make repayment for adjustment of the loan within four years' duration. If interest rate goes up, cost of fund also goes up. But the borrower will pay interest at the rate of 14% to the bank. It will reduce profit margin of the bank. How much the extent of loss of profit margin of a bank will be in a situation of contractionary monetary policy will depend on its loan portfolio management. If the percentage of long-term lending is greater than those of short-term nature, the bank will face decline in net worth as long as contractionay monetary policy exists.
The central bank's stance on contractionary monetary policy is aimed at lowering the inflation rate. But the volume of LC openings for the items that will be in greater demand during the month of Ramadan has so far been not up to the expectation. The prices of chick peas, lentils, spices, garlic, onion, date etc., will go up during Ramadan despite the government's withdrawal of duties from some essential consumer items. Flood is likely to cause supply shortage of agricultural products. In that event, inflation rate, already in double digit, will increase further.
Under such circumstances, serious doubts persist about whether contractionary monetary policy will yield any positive result by increasing statutory liquidity ratio (SLR) including that of cash reserve ratio (CRR) to bring down the inflation rate in the upcoming months. At present, commercial banks have to maintain CRR at 5.0% and SLR at 18% (including 5% of CRR) on their total demand and time liabilities.
..............................................
The writer works with One Bank Ltd., at Khatungonj Branch, Chittagong
THE latest decision of the Bangladesh Bank to increase the required reserve ratio and maintain it up to December 2007 demands a more cautious handling of asset-liability management by the commercial banks. Such banks cannot control the market-based interest rate. It is largely influenced by the central bank's monetary policy.
Demand for, and supply of, money determine the interest rate. Now banks are holding excess liquidity. Since the anti-corruption drive is going on, the matters relating to under-invoicing and over-invoicing are being monitored vigorously and some punitive measures have been taken by the government against some influential businessmen; the business community is still in a confusing state and suffers from lack of confidence due to a situation of panic that prevails in the country on real or perceived grounds.
They are not fully active yet being back in the business, despite government's repeated assurance about businessmen, not being involved in gross dishonest practices, will not be harassed. But a number of businessmen, particularly those who are involved in export and import trade, had been involved in over-invoicing and under-invoicing. Here exceptions are not many. However, the exporters are running their operations in the business-as-usual manner. The dominance of readymade garment (RMG) sector is one of the causes behind it. They are doing business in a more competitive global market. If any buyer switches over to another country, then the existence of the related exporter will be at stake.
But, in case of importers, the situation still remains different. Repeated government assurances, incentives like allowing waivers of duties in case of some essential consumer goods etc., are yet to have any positive impact.
The import business remains, on the whole, less buoyant, whatever the figures about opening of letters of credit may suggest. Despite this, the commercial banks will have to face the growing demand for money in the upcoming months in order to meet the demand for normal credit flow to the manufacturing as well as service sectors. Besides, they will have to make payment against LCs opened or to be opened for importing consumer items-related to the demand pattern during the holy month of Ramadan. The common people will require more money to spend for the month of Ramadan. Most of them, particularly those belonging to the middle class, require more money to meet the expenses on the occasion of Eid-ul-Fitr, the largest religious festival in the country. Under this situation, the banks holding excess liquidity will have to keep the fund with them to meet the customers' demand.
The country is now experiencing a severe flood almost all over it. Roads, bridges, dwelling houses etc., have been destroyed/damaged or will come under further damage. To face the post-flood situation, the government will be in need of a huge fund to meet the expenses for repairs of the damaged infrastructure. Agricultural sector will also be in need of fund. Shops, manufacturing units of flood-affected areas etc., will approach the banks for borrowing money. That is, the surplus money that the banks are holding will be needed to meet the demands for the same.
Since the government has adopted a more contractionary monetary policy, the bankers will have to face the situation in view of the possibility of their losses due to upward movements of interest rates. The bankers will have to calculate the duration of their respective banks' assets and liabilities. It is a value- and time-weighted measure of maturity that considers the timing of all cash inflows from earning assets and cash outflows associated with the liabilities. Banks receive interest earnings from its loans and securities and make payments of interest to the depositors.
A rise in market rates of interest will lead to a decline in the value of banks' fixed-rates. When the interest rate goes up, banks' asset value tends to decline, particularly for those assets having longer time for maturity. Longer duration maturity assets will decline in net worth when interest rates rise. Short-term loans will have less negative impact on their net worth. For example, if a loan which was disbursed one year back at the rate of interest at 14%, the borrower will make repayment for adjustment of the loan within four years' duration. If interest rate goes up, cost of fund also goes up. But the borrower will pay interest at the rate of 14% to the bank. It will reduce profit margin of the bank. How much the extent of loss of profit margin of a bank will be in a situation of contractionary monetary policy will depend on its loan portfolio management. If the percentage of long-term lending is greater than those of short-term nature, the bank will face decline in net worth as long as contractionay monetary policy exists.
The central bank's stance on contractionary monetary policy is aimed at lowering the inflation rate. But the volume of LC openings for the items that will be in greater demand during the month of Ramadan has so far been not up to the expectation. The prices of chick peas, lentils, spices, garlic, onion, date etc., will go up during Ramadan despite the government's withdrawal of duties from some essential consumer items. Flood is likely to cause supply shortage of agricultural products. In that event, inflation rate, already in double digit, will increase further.
Under such circumstances, serious doubts persist about whether contractionary monetary policy will yield any positive result by increasing statutory liquidity ratio (SLR) including that of cash reserve ratio (CRR) to bring down the inflation rate in the upcoming months. At present, commercial banks have to maintain CRR at 5.0% and SLR at 18% (including 5% of CRR) on their total demand and time liabilities.
..............................................
The writer works with One Bank Ltd., at Khatungonj Branch, Chittagong