Cenbank cuts lending to banks by 10% to rein in inflation

To tighten the money supply in the market and keep inflation under control, the Bangladesh Bank has reduced the loan amount given to state-owned and private banks through a repurchase agreement (repo) – a short-term lending instrument – by 10%.

Currently, the central bank lends to banks through repo for periods ranging from one to 14 days and charges 8% interest for a one-day or overnight loan, which is typically considered the lowest lending rate.

Policymaking officials at several public and private banks say since the announcement of the monetary policy in July last year, the Bangladesh Bank has provided all the money sought by banks, with some exceptions.

However, the central bank has not been doing that for the last two days. The policymakers said the central bank lent 5% less than the money demanded by banks on Wednesday and 10% less on Thursday.

Confirming the matter, several senior officials at the central bank told The Business Standard on Thursday that the money supply through repo was reduced by 10%.

"We have provided 10% less than the amount of money that banks are asking for. According to monetary policy, we are working to maintain the money supply in our country at a certain level. Based on our calculations, banks currently have excess money, which could have an adverse effect on inflation control. Therefore, we are planning to reduce the supply of money slightly," one of the officials said.

The latest monetary policy is interest rate-based, which was earlier reserve money based. That is, earlier, the central bank directly controlled the money supply. Now, that is maintained by raising or lowering the interest rate.

When asked why the reserve money is being directly reduced or increased without an accompanying increase in the interest rate, a senior official of the central bank responded, "We operate within an interest-based system outlined in the monetary policy. However, in an economy like ours, the money supply cannot be entirely controlled by interest rates."

"We set indicative targets for money supply and assess the reserve money accordingly. In the past, we used to align directly with the targets specified in the monetary policy announced by the central bank. However, we are making adjustments in the latest monetary policy," he added.

Indicative targets, which are flexible numerical trackers, may be set for quantitative indicators to help monitor progress in meeting a programme's objectives. Heightened uncertainty and limited capacity may justify greater use of indicative targets under certain circumstances.

The managing director of a bank has spoken against the money supply tightening move, saying if the central bank reduces lending in this way, banks will also adjust their requests for money accordingly.

"Because, if banks know that they will receive 10% less than what they want, then from the next day they will start demanding 10% more than what they actually need. It will not be possible to implement the policy that the central bank is trying to enforce," he added.

According to data from the central bank, banks have been borrowing between Tk12,000 crore and Tk20,000 crore daily from the central bank through repo, the assured liquidity support facility for commercial banks and financial institutions, and the Islamic Banks Liquidity Facility. On 1 April, banks borrowed a total of Tk25,006 crore in a single day. Last Wednesday, the central bank lent Tk15,240 crore to banks.

A repurchase agreement, also known as a repo or sale and repurchase agreement, is a form of short-term borrowing, mainly involving government securities. Dealer banks sell the underlying security to the central bank and, by agreement between the two parties, buy it back shortly afterward, usually the following day, at a slightly higher price.

Bankers say the demand for money in banks has increased over the last month. Demand typically rises before Eid. However, in addition to this seasonal increase, a significant amount of money is moving from the market to the central bank's vault due to the sale of dollars from reserves, effectively reducing the overall money supply.

Furthermore, many banks are facing challenges in managing their cash flow efficiently due to various irregularities. As a result, several banks are experiencing increased demand to borrow money, they added.

Syed Mahbubur Rahman, managing director and chief executive officer at Mutual Trust Bank, told TBS, "The central bank can reduce the reserve money for various reasons. However, it takes some time to see its impact on the market. They (the central bank) may be trying to understand the market impact by reducing the money supply."

According to data from the central bank, yesterday a commercial bank had to pay an average interest rate of 8.87% to borrow from another commercial bank overnight in the call money market. In this case, banks borrowed overnight loans at a maximum interest rate of 9.5%. Banks borrowed Tk3,147 crore overnight from this market on Thursday.