Pros and cons of single digit interest rate

For the last couple of months 'single digit rate of interest' has been the talk of the town in Bangladesh. However, this did not happen overnight, as it took nearly a year to bring the interest rate down to single digit. Merchant associations had been demanding a single digit interest rate for the last few years. 

After considering its pros and cons, the government set the highest deposit and advance rates at 6% and 9% respectively. But when this is implemented, investors, especially those at the grassroots, will be adversely affected. 

They will have difficulty in finding a suitable sector to invest. The capital market in Bangladesh is very unstable and it has already lost trust among investors. Given the level of insecurity, many investors are also reluctant to put money in non-banking financial institutions. Previously, government savings certificates were the first choice among investors. But right now it has become quite difficult to invest in savings certificate as the government has recently imposed some additional formalities.
In Bangladesh, it is really difficult to do business profitably. Like every other sector, instability also prevails in banking. There are about 62 banks working in the market. All are eyeing to collect deposits from the grassroots. That is why there is massive competition among the banks to attract potential clients. 

Almost all the banks are fighting against the classified loans, which has been increasing abnormally in recent years. Previously, the borrower used to take loan from the banks at more than 15%. The merchant associations were demanding reduction in the lending rate from the central bank and the government. In order to create an industry-friendly environment and accelerate trade, Prime Minister Sheikh Hasina gave strict directions to the banks regarding the reduction of interest rates. 

In accordance with her direction, The Bangladesh Association of Banks (BAB) decided to bring down the deposit rate to 6% and lending rate to 9%. And it will be implemented strictly from 1st April, 2020. 

The merchant associations expect that the lower lending rate will encourage local investment, reduce unemployment and enhance consumer confidence. 

Moreover, there was previously an unhealthy competition among the banks trying to meet abnormal annual targets. As a result of the fixed interest rate, unhealthy competition among the banks will be reduced when the rate is maintained by all the banks.
Experts think fixing the deposit rate ceiling will have some positive impact from micro-economics perspective, but from a macroeconomics perspective, it will have a massive negative impact on the overall economy. For the last couple of years the cost of living has increased. Now, very few people can save money after meeting their daily necessities and day by day their savings volume is reducing. 

Generally, people in the grassroots come to the bank to deposit their money and expect interest in return. They will be frustrated and reluctant to keep their savings in banks because of the low interest rate. Economists have expressed their concern that speculative institutions like Destiny, Unipay, Uniroot, Jubok, Aziz Co-Operative etc will once again emerge by offering lucrative rates to attract the innocent investors. 

Many clients may withdraw their money from banks and invest it in these speculative organisations. These so-called institutions will then convert the money into dollars and send it to the foreign countries by means of money laundering. As a result, the dollar rate will increase and the flow of remittance will fall. 

Moreover, the Government Savings Certificates are still being sold at 10%. A good number of investors, after fulfilling the respective formalities, will invest in savings certificates. As a result, government expenditure will be increased. As a result of lower interest rates, large business organisations will have an advantage over Small and Medium Entrepreneurs (SME). 

Because of fund crisis, the SME sector may be deprived of bank loans. Our current inflation rate is 6%. In such condition, it is really difficult to maintain a 3% spread. Moreover, due to the reduction in interest rates, even if the banks make a 3% spread, it will be difficult to make a bank profitable. As a result, their stock price will come down and shareholders will be deprived of healthy dividend. 

Experts have expressed concern that forceful reduction of interest rate will certainly affect the whole economy. Some countries have tried controlling interest rates forcefully in the past, but could not sustain it for long. Like Bangladesh, some years ago Kenya also tried to implement this fixed interest rate. But it could not sustain that and within three years it returned to the previous system. Interest rate is determined by the demand of money and supply of money. Experts think the issue of interest rate should be controlled by the market demand, and not by the government. When money supply will increase, deposit rates will decrease automatically.

Now, the main question in all the stakeholders' minds is whether the banks will be able to collect deposits at 6%. If yes, then there is no problem in lending to borrowers at 9%. But, if the banks cannot collect deposit at such a low rate, then it will be impossible to lend at such a low rate. To minimize this problem, Bangladesh Bank has recently issued a circular that funds from Annual Development Project (ADP) can be deposited with private commercial bank at 6% while at state-owned banks it will be 5%.

Finally, our government is committed to acheiving 8% GDP growth this year. To do this, total investment must be increased to 34% of the GDP. Without reducing Non-Performing Loans (NPL), if fresh loan is disbursed at 9%, then no positive result will come. So Non-Performing Loan must be reduced. The NPL of Bangladesh (11.9%) is higher than the NPL of India (11.2%) and Pakistan (8.8%). Moreover, banks need to give more attention to the reduction of their own operating costs. Corporate overnance must especially be ensured in restoring the health of the banks.

The author works at Pubali Bank Limited, Board Division, Head Office, Dhaka. He is also an Associate Member of the Institute Of Chartered Secretaries of Bangladesh (ICSB).