Bankers worry deposit rate cap may hurt lending, profit

One and a half years back, the Bangladesh Bank had to force banks to implement a 9% lending rate to bring down financing costs.

But the loan now is cheaper than that as interest rates came down to the 6% to 7% level and the fall in lending rate is the result of market forces.

The current lending rate situation reflects how market forces drive money market rates.

However, the central bank did not take lessons from here as it has again moved to control money market rates, putting a cap on the minimum deposit rates, which goes against the open market economy.

On Sunday, the Bangladesh Bank issued a circular, barring banks from lowering deposit rates below the inflation rate.

The inflation rate has been on an upward trend in recent months and stood at 5.56% in June. If banks have to fix deposit rates above inflation, it will give a small return to depositors but push the lending rate up.

The deposit rate cap has annoyed bankers as it will hurt bank's profitability severely, making it difficult for them to keep the lending rate at 9%.

The Association of Bankers Bangladesh (ABB) has expressed its deep concern over the deposit rate cap and decided to sit with the Bangladesh Bank for reconsideration of the decision. 

"We are lending at 7% while taking deposits at 3%," said Ali Reza lftekhar, managing director of Eastern Bank and also the chairman of ABB.

"If the deposit rate is set above average inflation of 5.59%, how will banks lend at 7%?" he asked. 

"We learned that the central bank took the decision considering that the number of personal deposits is low, but that is not correct. Actually, maximum deposits in private banks are of individuals and of them, 50% to 60% are fixed deposits, meaning that banks will have to increase interest rates against the major share of deposits."

"If the deposit rate is set based on the average inflation rate, banks will see a 2% hike in deposit cost. Moreover, if inflation goes up to 6.5%, how will a bank lend at 9%?" he wondered. 

"I think there is a misunderstanding about data calculation and that is why we will meet with the Bangladesh Bank from the ABB to discuss the issue," the ABB chairman said.

The deposit rate cap is a major decision, but it was taken without consulting the stakeholders, he added. 

Currently, banks are staying profitable at this crisis period by minimising operating costs and improving efficiency. The deposit rate cap will have an impact not only on lending rate but also on banks' profits, Ali Reza pointed out. 

Deposit rate matters little to depositors as banks are getting good deposits even at low rates. Foreign banks are getting deposits even at 1%. So, the issue is not with interest rates but with service quality and reputation of banks, he opined. 

The central bank's intervention on deposit rates has created huge criticism in the financial market as controlling interest rates is taking the banking system back from an open market economy, creating a negative impression in the global forum. 

Interest rate matters little to depositors and lenders, which is reflected in both deposit growth and private sector credit growth. 

For instance, when the lending rate is at its historic low, it could not attract borrowers, causing the lowest private sector credit growth in recent times.

The private sector credit growth was 8.4% in the last fiscal year when the monetary target was 14.8%. 

It proves that financing costs hardly matter to investors. There are other factors like investment environment and economic stability that actually matter. 

Businessmen have now shied away from business expansion amid the ongoing lockdown put in place to rein in the pandemic. 

When the banking sector experienced a historic low interest rate, private investment dipped to a 14-year low.

The private investment to GDP ratio declined to 21.25% in the last fiscal year, according to the latest data released by the Bangladesh Bureau of Statistics (BBS).

The deposit rate cap will push up both lending as well as deposit rates, said Abul Kasem Khan, former president of the Dhaka Chamber of Commerce and Industry.

If the lending rate increases, it will have a negative impact on businesses, said Kasem, who is also chairperson of the trustee board of the Business Initiative Leading Development (BUILD).

However, besides the lending rate there are other factors behind an investment plan such as the investment environment and ease of doing business that play a significant role in investment decisions, he said.

On the other hand, when deposit rates came down to 2% to 3%, the lowest level in recent history, and in the case of some banks, it was as low as 1%, it did not affect deposit growth. 

The deposit growth was above 13% to 14% during the pandemic year, according to the central bank data. 

The fall in deposit rates hurts small savers making their return negative from bank deposits, but the central bank apparently seems responsible for their woes. 

The lowest deposit rate is the spillover effect of excess liquidity and lending rate cap.

The Bangladesh Bank has set a 9% lending rate cap from 1 April last year. As a result, banks went for a massive cut in deposit rates to adjust their fund costs. 

Meanwhile, the central bank pumped huge excess liquidity into the market through relaxing monetary instruments during the pandemic, aiming to make money cheaper. 

The excess liquidity, which stood at the historic highest level of Tk2.39 lakh crore in June, has now turned into trouble for banks, creating price pressure and bringing down deposit rates at the bottom.

Economists and financial market experts highly criticised the deposit rate cap sharing their reactions at an online group named the Bangladesh Economic Forum. 

In his reaction, Dr Ahsan H Mansur, executive director of the Policy Research Institute, said "This is completely inconsistent with the market-based banking operations. The central bank should do aggressive mopping up of excess liquidity and work on reducing the rate of inflation."

"This policy at this time of high liquidity and inflation will force banks to find ways not to accept term deposits. The deposits will shift to highly risky non-bank financial institutions that are hardly regulated. Money will also move to speculative activities. I wonder why a reputed institution like the Bangladesh Bank issues such a directive without consulting with stakeholders and assessing proper risks."

"Interest rates fell owing to the expansionary monetary policy in the backdrop of the pandemic as well as low demand for credit," said Asif Khan, managing partner at the EDGE Research and Consulting Limited.

"Therefore, it is quite normal for deposit rates to be low and this is what we are seeing across the world. Instead of fixing a ceiling, which goes against market driven rates, it would be better to use monetary policy tools to get interest rates higher. Even that raises questions because it may be premature to change policy stance, given the second and third waves of Covid-19," he added.