Central bank moves to mop up excess liquidity from banks

The Bangladesh Bank has decided to mop up excess liquidity from banks by issuing bills, aiming to control price pressure and keep the money market stable.

The central bank's intervention has come just a week after it announced an expansionary monetary policy for the current fiscal year.

The Bangladesh Bank Bill is a monetary instrument used to mop up liquidity from the market.

The central bank is set to start issuing bills from 9 August through auction after a break of three years. The last auction was held on 29 March 2018.

All banks have been notified about the auction through a letter on Thursday, said a senior executive of the Bangladesh Bank.

The total excess liquidity in the banking sector almost doubled in the last one year and stood at Tk2.39 trillion this June. The figure was Tk1.39 trillion in the same period last year, according to Bangladesh Bank's data.

High inflows of remittance sent by expatriate Bangladeshis have mostly contributed to excess liquidity as the central bank is purchasing dollars from the market injecting money.

Remittance inflows hit a record high with over 36% growth in the just-concluded fiscal 2020-21 despite the pandemic.

Moreover, during the pandemic time, the central bank reduced rates of monetary instruments like CRR (cash reserve ratio), repo and reverse repo and ADR (advance deposit ratio).

Low demand for credit in the private sector has also contributed to the piling up of surplus liquidity in the banking system.

Private sector credit growth was 8.4% in the last fiscal year against the monetary target of 14.8%, Bangladesh Bank data show.

In the new monetary policy, the Bangladesh Bank has addressed the ample excess liquidity as a concern for the money market and hinted at controlling it anytime if necessary.

"The presence of a huge amount of surplus liquidity in the economy attributed to the on-going expansionary fiscal and monetary stances may also contribute to creating some price pressures in the days ahead," said the central bank in its monetary policy announced on 29 July.

"In case of any unexpected price pressure development or formation of any sporadic asset price bubbles due to the presence of ample excess liquidity in the banking system, the BB will not hesitate to take appropriate policy action if required, throughout the year ahead," it said.

The Bangladesh Bank's move to control excess liquidity has come after the private think tank Centre for Policy Dialogue (CPD) emphasised the need for mopping up excess liquidity.

The think tank also called on the Bangladesh Bank to reconsider its expansionary monetary stance at a press briefing held recently to express its reaction to the monetary policy statement for FY22.

Dr Fahmida Khatun, executive director of the CPD, said the sharp rise in excess liquidity in the last one year has led to a fall in call money rate and lending rate.

"Excess liquidity in the banking system may induce commercial banks to behave in ways which may jeopardise the stability of the financial system and make it difficult for the central bank to achieve its monetary policy goals," she said. 

"Banks may make attempts to offset their losses from holding excess liquidity by giving out risky loans, which may lead to higher volume of default loans, higher inflation and the creation of asset bubbles."

Amid this situation, the Bangladesh Bank can increase the CRR requirement to mop up excess liquidity, she suggested.

CRR is the share of banks' total deposits that is mandatory to maintain with the central bank. The Bangladesh Bank reduced CRR from 5.5% to 4% during the pandemic.

The persistence of surplus liquidity in the system resulted in a sharp decline in the call money rate from 5.01% in June 2020 to 2.25% in June 2021, according to Bangladesh Bank data.

In the new monetary policy, the central bank explained that it intentionally refrained from conducting any liquidity sterilisation action as a part of its employment and investment supporting pro-growth expansionary policy stance considering the Covid-19 pandemic situation and maintaining safe positions of the key anchoring monetary and credit variables and supporting interest rate rationalisation efforts on lending.

The central bank will, however, ensure a constant vigil monitoring the commodity and asset price developments along with the progress in money as well as foreign exchange markets and will take appropriate policy measures as required.

However, the central bank changed its stance on keeping money flow after various platforms stressed the need for clearing up excess liquidity for the sake of taming inflation.

Inflation is already on the rise. The inflation rate was recorded at 5.56% in FY21, overshooting the government's target of 5.40%.

In June this year, inflation was 5.64% – the highest in the last eight months.

The interest rate of the Bangladesh Bank Bill will have to be above the rate of treasury bills to encourage banks to park money with the central bank, said Mirza Elias Uddin Ahmed, managing director of Jamuna Bank.

The interest rate of short term treasury bills has come down to below 1% due to huge excess liquidity.

The decision of mopping up surplus money will create an artificial crisis in the market that will push up the interest rates of loans and deposits, the Jamuna Bank observed.

Currently, most banks are collecting deposits at 3-4% interest rate while the lending rate is 6-7%.