Home ›› 15 Jan 2023 ›› Editorial
As a stopgap arrangement, interbank bank borrowing is an essential source of funds for banks and financial institutions failing to address immediate liquidity management.
The three types of borrowing, such as overnight, short notice [4 days], and short notice [5 days], are common in Bangladesh. The interest rate on different types depends on the nature of borrowing and the supply of funds. Interbank borrowing helps deficient reserve banks borrow from banks with excess reserves. The interest rate in interbank borrowing is the call money rate in Bangladesh; it is the federal funds rate in the USA. In the UK, it was London Interbank Offered Rate [LIBOR] till 2021 but now replaced by Secured Overnight Financing Rate or SOFR. the SOFR is based on actual overnight transactions in the Treasury repo market, is more accurate in measuring the cost of borrowing money, and cannot be easily manipulated. The problem with LIBOR was detected in 2012 when banks rigged the rate.
The panel banks that gave LIBOR estimates collaborated and submitted false data to profit more from trades. Again, there was an element of uncertainty when panel banks quoted hypothetically estimated rates when lending to one another. Thus the Financial Conduct Authority (FCA) announced in 2017 that it would phase out the benchmark by the end of 2021.
Besides the mismatch between the nature of deposits and the lending practices by the banking institutions, the call money rate depends on the nature of monetary policy tools and occasionally on seasonal environments. Banks in Bangladesh usually face liquidity pressure ahead of Eid festivals.
People withdraw significant funds from banks on the occasion of Eid-ul-Azha to meet the expenses for buying sacrificial animals and other expenditures. The formal financial sector comprises the money market, banking system, microcredit institutions, nonbank financial institutions, and interbank foreign exchange markets. The Bangladesh Bank and the Ministry of Finance govern operational activities in the formal financial sector. An increase or decrease in Cash Reserve Requirement [CRR] could affect the fluctuation of the call money rate. Thus the reduction of CRR from 6.50 percent to 5.50 percent eases the liquidity crunch.
On the other hand, an increase in the CRR from 5.00 percent to 6.00 percent raises the overall statutory liquidity ratio to 19 percent. This may wipe out several billion taka from the money market as the bank needs to maintain Taka 6 as cash and Taka 13 in the form of bonds with the central bank against a deposit of Taka 100.
The call money market often experiences instability with changes in the policy rates and money market conditions. The call money market was stable until 2001, with a few minor exceptions. There were no jerks with evident spikes. The money market was experiencing a liquidity crisis in FY 05 with withdrawals from the market by the government. One reason the government borrowed from the money market is to curb inflation. Also, the government could not inject extra funds through sterilization in the face of lean aid flow.
The market experiences volatility hovering in the range of over 15 to 20 percent. The volume of trade was 331 billion taka with an interest rate of 5.4 percent on July 05, the call money rate jumped to 15 percent with the volume of transactions 470 billion taka on January 2006, and on April 2006, it climbed to 22 percent with the book of transaction 470 billion taka. The rate was 11 percent on June 2006, with the volume of transactions at 395 billion taka.
Another instability was observed in FY 2011, the trading was smooth in FY 10, but in December FY 11, the weighted average interest rate peaked at 34 percent with a volume of trading of 653 billion Taka. However, the weighted average interest rate was 11 percent, with an average volume of trading at 718 billion taka. This represents a 275 percent average increase over FY 10, with an average trade volume of 480 billion taka. Thus the interbank money market faced liquidity stress at the end of FY 11.
The factors behind the stressed condition were asset-liability mismatches hidden in loose monitoring by BB and the participating bank. The increased demand for domestic credit as the economy paced up to the expected positive economic growth, coupled with heavy outflows for imports and other external payments, put the banks under liquidity pressure. Again, unauthorized investment in the unproductive sector or dubious lending put banks into liquidity pressure. The practice of prudent advance-deposit ratios, regulatory ceilings on capital market exposures, and tightening loan monitoring requirements to discourage the diversion of credit to unauthorized and unproductive uses are some of the remedial measures in arresting the abrupt changes in the call money rate.
The trend of the rate in many instances suggests a sharp spike, such as in March 2006 and April 2006, when the rate jumped from 16 percent to 21 percent. The enforcement of prudent advance-deposit ratios and regulatory ceilings on capital market exposures and tightening loan monitoring requirements to discourage the diversion of credit to unauthorized and unproductive uses could help minimize the instability.
The recent controversy on the call money rate rests on the capping lending interest rate at 9 percent since 2020, but banks with CRR shortfall are borrowing and paying more than 9 percent. The BB injected a large volume of funds to help maintain CRR and injected USD 7.50 billion to help banks clear import bills amid a shortage of dollars that weakened the liquidity position. Further, non-payment of the loan amount originated through the stimulus fund may be another reason. Lending interest rate caps imposed earlier in the backdrop of the global slowdown is no longer tenable in the changed context of high and rising demand, phase out of these caps was initiated, starting with loans [credit card] other than industrial term loans and loans for export, agriculture and essential imports. The higher loan cost may squeeze the profit margin, so withdrawing the interest rate cap on both deposits and lending is the only way out. The banks may augment deposits at the current inflation rate of 8 percent with a profit margin.
The writer teaches at BRAC University and BIDS as an adjunct Faculty in the Master’s Programme in Economics. He can be contacted at [email protected]
