Interest rates: Capped or uncapped?

The Bangladesh Bank has been generous in showering big borrowers with one concession after another to prevent them from defaulting, but it is yet to show any concerns regarding the plight of depositors – who are grappling with an interest rate disproportionate to the inflation.

The central bank itself had previously mentioned that the interest rate on deposits should never go below the 3-month average inflation. The reality however tells another story, as the banking system is now punishing depositors, instead of benefiting them.

Inflation is now around 9 per cent, but the average interest rate on deposits is only 4 per cent. A quick calculation shows that the interest rate for depositors is around negative 5 per cent. This means if a depositor keeps Tk 100 in a bank, he/she is actually getting Tk 95.

Several industry insiders and experts point out that if the deposit interest rate does not increase amid the liquidity crisis, the banks may face severe fund shortages. There is no way to hike the deposit interest rate unless the loan interest rate is increased as well.

However, the central bank is unwilling to remove the existing 9 per cent interest cap on loans. Experts say the situation could exacerbate the country’s ongoing economic troubles.

On the issue, former director general of Bangladesh Institute of Bank Management (BIBM) Toufic Ahmad Choudhury said, “If the interest rate increases, deposits in the bank will go up too.

“As negative returns are now coming from deposits, so many people are withdrawing money from banks. If this situation continues, the banks’ liquidity crisis will certainly deepen.”

A senior banker, on condition of anonymity, said, “If we increase the interest rate on deposits as per the instructions of the central bank, we will not be able to run the banks. To increase the interest rate on deposits, the interest rate cap must be lifted.

“However, the interest rate on deposits is now slightly increasing, and it has already gone up to 7 per cent to 7.5 per cent in different banks.”

‘Making policy decisions appropriately’

Discussing the current deposit interest rate, central bank officials say the circular in this regard was issued at a time when the economy was somewhat normal in both home and abroad. But the situation changed drastically after Russia invaded Ukraine.

Economic policies introduced in normal times may not work under shifting circumstances, they added.

Bangladesh Bank Executive Director and spokesperson Md Mezbaul Haque said, “We will not do anything that may negatively impact the country’s production and employment sectors. We are monitoring the situation, and making policy decisions appropriately.

Echoing the same, several central bank officials say if the interest rate on deposits is increased, the interest rate on loans should also be increased as well.

As the country is now under the pressure of inflation, if the interest rate of the loans is increased, the cost of production will increase too, and the price of the product will rise further.

They added that the industries will suffer due to the decrease in product sales. As a result, the workers of such industries will lose their jobs. Moreover, if these businesses default, the country’s overall industrial production will be severely impacted.

Central bank officials point out that considering the above mentioned factors, the central bank is providing multiple facilities in a bid to prevent loan defaults.

Under a recently introduced facility, no one will become a defaulter if they manage to pay 50 per cent of the installment within this month. This amount was previously set at 75 per cent.

Experts favour lifting the cap

Experts say there is no basis for concerns that the country’s economy will be in a deeper crisis if the loan interest rate is increased. They claim that it is a common practice in many countries to raise interest rates to curb inflation.

The Bangladesh Bank also hiked the policy rate (known as repo rate in Bangladesh) on multiple occasions, which now stands at 5.75 per cent.

Toufic Ahmad Choudhury said, “Inflation and employment do not go together, they move in opposite directions. If you want to control inflation, you will definitely have to handle at least some unemployment.

“In recent times, both unemployment and inflation are rising here. This phenomenon is called stagflation in economics. So I think the deposit rate should be increased by lifting the lending rate.”

Voicing the same, a banker, preferring to be anonymous, said, “The cost of living has increased a lot due to the more than 50 per cent increase in fuel prices. Lifting the interest cap on loans will have a minor effect on the public’s current living costs.”

What’re the BB instructions?

The regulator has capped the loan interest rate at 9 per cent in April 2020 following demands from the business community and recommendations from the government. However, there was no guidance regarding interest rate on deposits.

As a result, banks reduced the interest rate on deposits by a lot.

The Bangladesh Bank later issued a circular on August 8, 2021 due to a controversy in this regard. The circular mentioned that most banks’ deposit interest rates are lower than inflation, and this may create an imbalance in the bank’s asset-liability management.

To prevent this imbalance, the 3-month average inflation rate should be taken into account in case of any type of term deposit spanning three months or more. However, the loan interest rate will remain unchanged at 9 per cent.

What’s the inflation situation?

Inflation rate rose to a decade-high of 9.52 per cent in August this year due to rising commodity prices in the international market, and the USD crisis following Russia’s invasion of Ukraine.

Then there was a slight decrease in September to 9.1 per cent, and it further decreased to 8.91 per cent in October. The three-month average inflation stood at 9.17 per cent.

During the same period, the average bank deposit interest rate was 4.07 per cent in August, 4.09 per cent in September and slightly increased to 4.13 per cent in October. The three-month average stood at 4.09 per cent.

Deposits, liquidity situation

The growth of bank deposits has slowed down due to the inflationary pressures, rising living costs, negative real interest rate and lack of confidence in banks due to irregularities.

According to the central bank, the total amount of bank deposits in the country reached Tk 14.9 lakh crore at the end of this October. The deposit growth in October was 7.35 per cent, a decline from 11 per cent when compared year-on-year.

Excess liquidity of the banking system is going down. At the end of October, excess liquidity stood at Tk 1.69 lakh crore, which was around Tk 2.20 lakh crore in October last year, showing a dip by Tk 51,000 crore.