Banks' deposits rate is falling. Depositors' return has been cut significantly compared to what it was one or two years back. Retired persons in particular are the worst victims of this. A few days back, this writer met his uncle who is passing retirement life with his retirement benefits kept in banks to run his family expenses. He expressed his concern over the reduced rate of return against his deposits in banks and also asked this scribe about the reason behind this.
This writer explained the situation with the dynamics of banking and economics. He started with a very naive definition of banking i.e. a bank acts as an intermediary institution by buying idle money from the surplus unit of society and selling the same to the deficit part of society at a rate higher than that of buying. By creating positive gap between the selling and buying rates which is called spread in banking terms, profit is made in banks. However, since banks deal with public money, it has to follow certain rules and regulation of the regulatory authority meticulously.
Now-a-days, depositors are getting lower rate of return as all the banks have been compelled to reduce its deposits rate in the back of their shrinking yield on advances. As example, he mentioned that the bank's average yield on advance was reduced to 11.18 per cent in December 2015 as compared to 13.45 per cent during the same period two years back i.e. December 2013. As a reason, he said banks currently have a huge amount of investible fund but there is no enough scope to utilise those. As per the Bangladesh Bank's data, the banking sector's Advance-to-Deposit Ratio (ADR) was reduced to only 69.8 per cent in September 2015 against the central bank's recommendation of up to 85 per cent and 90 per cent for conventional banks and Islamic Shari'ah banks respectively. Such a low ADR in banking sector is an indication that there is huge surplus money in banking sector waiting to be utilised. Both demand and supply factors have led the banking sector to be flooded with huge investible fund.
 On demand side, credit growth has been low mainly due to lower private sector investment demand as investors' confidence is yet to be restored. As per the Bangladesh Bank data, domestic credit recorded an increase of 10.31 per cent (y-o-y) at the end of November 2015 against that of 10.99 per cent at the end of November 2014. On supply side on the other hand, the economy saw substantial amount of foreign currency loan since access to international market was liberalised in 2008. Currently, the Bangladesh economy has around US$ 8 billion of foreign currency loan in the form of direct borrowing from foreign sources and through UPAS LC at interest rate of maximum 6 per cent over the last few years. Corporate clients having sound track record of transactions are more interested to borrow from foreign sources at a relatively lower rate of interest as compared to that of local banks. Besides, inclusion of nine new banks at a time in the year 2013 has impacted supply side positively. Hence, on one side, demand for domestic credit has been reduced and on the other, supply of the same has been increased simultaneously.  Â
Graphical presentation reflects how the dynamics of demand and supply of credit reduced the lending rate. In the figure, original demand curve D0 shift downward to D1 due to ongoing subdued demand for loan and for this, equilibrium interest for loan reduced from r0 to r1. Interest rate was reduced another spell to r2 due to increased supply as reflected by rightward shift of supply curve from S0 to S1. Â
 Bank usually considers a few factors like cost of funds, cost of CRR and SLR, cost of administration and cost of equity capital while determining the lending rate. Since market forces compelled banks to reduce their lending rate, banks had no other option other than cutting deposit rate across the board and simultaneously enhancing its efficiency to overcome the downward pressure on spread. Because, if acceptable amount of spread is not ensured, profitability of a bank will be affected adversely and consequently key performance indicators of the bank including Return on Assets (ROA), Return on Equity (ROE) and Capital to Risk-weighted Asset Ratio (CRAR) will be affected negatively. More importantly, dividend payout capacity of the bank will be shrunk and therefore they will not be able to satisfy shareholders' expectation in terms of dividend for which actually shareholders wait round the year. This will ultimately hit the stock price of the banks negatively. Â
As long as investment demand and subsequently demand of loan from domestic banks do not pick up, the situation will not be changed. The renowned Fisher Equation of Economics demonstrates link between nominal and real interest rates. In other words, to get real interest rate of deposits, inflation is to be adjusted from nominal interest rate. The Fisher Equation is as below:
Nominal interest rate ? Real Interest rate + inflation rate or     Â
 Real interest rate nominal interest rate inflation rate.    Â
Real rate of return of depositors was reduced to only 0.24 per cent as on December 2015. As such, if the trajectory of reduced deposits rate continues and inflation rate increases a bit then real rate of return would be negative for the depositors.
It is really worth appreciation that the central bank has successfully brought down the average lending rate of banks close to single digit (Table 1) which is the demand of business society since long. Obviously, this will be instrumental to create more entrepreneurship in the economy and thereby increase investment demand. It is worthwhile to mention that our current GDP-Investment ratio is 26 per cent but it should be at least 32 per cent to upgrade our status as a middle-income country from lower-middle income one. However, lower interest rate indeed is a necessary but not sufficient condition to create investment demand in the economy. Because, some other factors including supply of gas and electricity, proper infrastructure, political stability, good law and order situation and consistency in policy support must be ensured to invite local and foreign investors to invest in the country.
Data reflects that real interest rate of depositors is in decreasing trend. As on December 2015, this figure was only 0.24 per cent which is the lowest in the last couple of years. Under this purview of declining deposits and lending rate trajectory, in order to safeguard the depositors' welfare, inflation rate must be controlled in such a way that real interest rate against the deposits remains attractive. Because if the real interest rate seems unattractive to depositors, they may start searching alternative sources to park their deposits at a better rate which may result in adverse consequences like:
n Selling pressure on high-yield savings instrument will be mounted up which will ultimately put pressure on the government's interest expenditure.
n Savings may go to informal channels like unauthorised MLM companies and consequently depositors may be cheated.
n The economy may experience inflationary pressure as depositors may prefer consumption to savings.
n The country may face capital flight. Â
n Savers may be inclined to speculative businesses.
n Last but not least, saver's Marginal Propensity to Save (MPS) will be reduced and therefore the economy will lose savings and therefore internal capital generation.
Here, we would like to mention the famous Tinbergen Rule of Macroeconomics which says, " In order to resolve all the macroeconomic woes simultaneously without tradeoffs, the government needs at least as many effective instruments as there are targets. This is due to the fact that a policy instrument can have favorable impacts on one target but unfavorable impacts on others." It is perceived here that in the way to bring down the bank's lending rate to single digit, depositors are being affected in terms of real rate of return.
Since, plummeting deposits rate, the consequence of lower lending rate of banks, is set to hit hard the depositors, in accordance with the Tinbergen Rule of Economics, the authorities concerned must have to adopt other effective policy measures to offset the adverse impact of declining rates to the depositors.
The writer is Principal Officer, Mercantile Bank Limited, International Division. Views in the article are the author's own and do not necessarily reflect the official position of the bank he is associated with.
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