Liquidity crunch: The solution lies in the problem itself

The interbank lending rate jumped past the official rate on several occasions in the last one and a half months as some banks desperately needed cash to stay afloat. They borrowed from other banks for one day at 6.8% interest rate on average or for two weeks at over 10%.

Those banks are, however, supposed to lend money at a maximum of 9% rate. But when they themselves borrow at a higher rate, the situation offers nothing pleasant. An instant diagnosis of the diseases always detects the same old viruses in the financial system: soaring non-performing loans, monstrous loan scams over the years, and so on.

Over the past several days, the interest rate on overnight loans has been 6.80% -- the highest in the last six and a half years. This rate tends to rise when the demand for banks to borrow money from other banks increases owing to a liquidity crunch. 

In fact, the call money rate has been on the rise since November. Most banks started lending at short notice of 2-14 days at higher interest rates due to the central bank-imposed restrictions on overnight interest rates. The interest rates on these loans went up as high as 10.50% in December itself. Eventually, the central bank verbally imposed a 9% cap on the interest rate on interbank lending, forcing the rates to come down.

However, bankers say that trying to handle the situation in this way can make the situation worse. Interest rates in loans must be based on market demand and supply, they add. 

They continued to say that already, banks do not want to lend to their weak peers. In such a situation, capping the lending rate will make banks fully stop lending. As a result, the liquidity crisis of some banks will rise to the extreme.

Amid the depleting liquidity in the banking system, the government instead of taking out loans from commercial banks for budget support is paying them back by borrowing money from the central bank. 

According to the Bangladesh Bank's data, the government has borrowed Tk65,605 crore from the Bangladesh Bank in the last six months, of which Tk33,355 crore has been used to repay loans to commercial banks.

As such government borrowing from the central bank has increased, while that from the commercial banks has fallen. The net debt of the government from the banking system in the first six months of the financial year 2022-23 stood at Tk32,249 crore.

Basically, the central bank provides the government with loans against treasury bills and bonds. These bonds with a tenure of 1-20 years are being purchased by the central bank itself. 

The interest rate on long-term government bonds shot up to 8.95% in the last auction called by the Bangladesh Bank on 28 December – at a time when the lending rate cap was 9%.

The money that Bangladesh Bank releases in the market is all reserve money or newly printed money. The central bank releasing money means releasing high power money in the market. If lending by the central bank increases, the supply of money in the market increases, which adds to inflation pressure.

Economists say that an overflow of money in the hands of the general public leaves less impact on the economy because the money is not invested. As a result, employment decreases, and GDP growth is affected. 

On the contrary, when money is deposited in banks, it changes hands much more frequently, adding momentum to the economy, they add.

Banks in the country had Tk1.70 lakh crore in excess liquidity last October. But only Tk12,740 crore was actually usable. In October 2021, the amount was Tk34,410 .

Why liquidity crunch takes place

The causes of a liquidity crisis can be broadly divided into several categories, according to economists. 

The first of these is to sell dollars from the central bank reserves to commercial banks to meet the dollar crisis in the market. According to central bank's data, $1.26 billion was sold from reserves in 2022 – meaning around Tk1.20 lakh crore has gone from the market to the central bank's vault.

Secondly, the difference between deposits and loans. People are reducing deposits in banks due to rising inflation and low-interest rates on deposits. What is more, some people are breaking their savings to run the cost. 

According to the latest data, deposits in the banking system fell by around Tk3,000 crore in November last compared to the previous month. The year-on-year growth in deposits was 7.74% in September 2022, which decelerated to 6.68% two months later. On the other hand, credit growth was much higher, although the YoY credit growth slowed in November (10.93%) compared to September (11.85.

Thirdly, loans given to businesses are not being paid on time. Borrowers have been given various benefits including moratoriums on loan repayment in the wake of the Covid pandemic, the Ukraine-Russia war etc.

According to the latest instruction of the central bank, a down payment of 2.5%-4.5% is required to regularise defaulted loans. Earlier, 10%-30% of a loan had to be paid for its regularisation. Banks rescheduled Tk5,551 crore of their defaulted loans in the July-September quarter last year, which is nearly 50%  – or Tk1,845 crore – higher than the previous quarter. In the April-June period of 2022, the amount of rescheduled loans stood at Tk3,706 crore.

According to central bank data, at the beginning of 2022, the amount of defaulted loans at banks was around Tk1.03 lakh crore. At the end of June, the amount increased to Tk1.25 lakh crore, and it further rose to Tk1.34 lakh crore at the end of September.

Fourthly, the above factors have created a chaotic situation in the liquidity management of some banks. Sometimes some banks are not able to keep the cash-to-reserve (CRR) ratio at the required level. State-owned banks are facing a liquidity crisis due to high defaulted loans and buying dollars from the central bank. Besides, several banks, including five Islamic banks, are facing a liquidity crisis due to the non-recovery of loans. Several banks were unable to maintain the required CRR in November and December last.

Lastly, negative news and rumours were the final nails in the coffin of the banking sector. Due to these reasons, customers are withdrawing deposits at a greater propensity, which has triggered the liquidity crisis.

Are all banks suffering from liquidity crunch?

Not all of the 61 banks operating in the country are facing a liquidity crisis. There are many banks that have surplus liquidity and are lending to other banks almost on a daily basis. But there are some banks, whose liquidity base is not good as they are seeking loans from other banks.

A deputy managing director of a leading local bank, who does not want to be named, said that it takes several years for a bank to run smoothly after its establishment. From that point of view, the third and fourth-generation banks in the country have not got the opportunity to develop in that way. Their image in the market is also not very positive. As a result, they cannot collect deposits that way. These banks are suffering the most due to the rumours.

He said at least 23-24 banks will be included in the list of affected banks and there is still pressure to withdraw customer deposits. This is why the banks where customers are coming to withdraw more deposits or whose balance sheet is small, are in a liquidity crisis.

He further said, "The amount of term deposits of less than one year is high in the country. On the other hand, banks have to provide long-term loans. As a result, you will not get back all the loans even if you want. But the banks return most of the deposit money on demand."

If the pressure of deposit withdrawal is not reduced, the liquidity crisis in banks will increase, he said.

What should be the central bank's monetary policy?

The central bank is going to announce the new monetary policy for the January-June period of this year on Sunday. 

In a meeting, Abdur Rouf Talukder, governor of the Bangladesh Bank, said that the loan interest cap will not be lifted. Now the question arises, how will the central bank formulate the monetary policy keeping this rate fixed? This institution, which is the policy maker in the country's financial sector, wants to focus mainly on stabilising the exchange rate of the dollar in the monetary policy.

Economists complain that the central bank is not lifting the interest rate cap to provide cheap loans to influential businessmen. As a result, the amount of debt is increasing, but the deposit is not rising compared to that. The liquidity crisis is increasing due to the gap in this area.

Zahid Hussain, former lead economist of the World Bank's Dhaka office, said the central bank should now lift the interest rate cap. "Interest rate should be market-based. The central bank of our country mainly formulates monetary policy by targeting reserve money. Since this tool is in the hands of the central bank, they can control it very easily." 

However, he said that the use of this tool will not be very useful by keeping a cap on the interest rate.

Noting that the reserve money should not be increased, the economist said that the rise in the reserve money means an increase in the money supply in the market and this will trigger inflation.

Zahid Hussain said if the amount of deposits does not increase, it will be difficult to deal with the liquidity crisis, and people must be encouraged to make deposits.

"Due to the ongoing inflation, the deposit is unlikely to increase, but we have to try. Because loan growth will increase due to low-interest rates, in this case, if deposits are not increased, the banking sector will face more problems," said the eminent economist.

He further said that a huge amount of physical money has gone to the underground economy instead of the banking channel.

Ahsan H Mansur, former economist of IMF and executive director of the Policy Research Institute also emphasises the need to lift the interest rate cap. The economist further advised the government to stop money laundering.

He told The Business Standard, "The currency and dollar crisis are linked to each other. Money is being laundered from the country through various channels including hundi, over-invoicing and under-invoicing. We have to stop money laundering to stop the dollar crisis."

Arfan Ali, former managing director of the Bank Asia, said, "Extending the time while converting the loans of the incentive packages into term loans at different times is also a reason for the liquidity crisis in banks. Otherwise, the loans would return to the banks and the banks could then lend again. Due to this, there will be a little tension of money in the banking channel this year. It will be a bit difficult, especially for weak banks."