Bangladesh Bank starts correcting rate spread calculation

Banks and non-bank financial institutions have been wearing an impression of a strong performer with low lending rate and spread gap.    

However, the magic lies in distorted weighted average stemming from an old calculation formula that considered zero interest rate against non-performing loan (NPL) amount.

The Bangladesh Bank has now started correcting the weighted average lending rate calculation system to bar banks and non-bank financial institutions (NBFIs) from keeping their interest spread artificially low to make their financial health look good.

The spread-gap between lending and deposit rates is an indicator to measure business efficiency of financial institutions and the regulator takes necessary corrective measures based on this indicator. The Bangladesh Bank controls aggressive hike in lending rate of banks and NBFIs based on the spread.

Highlight: TBS

The central bank has found that the current calculation does not reflect the real lending rate scenario of the market, making it difficult for them to take appropriate policy steps.

It noticed the faulty calculation when the spread of an NBFI became negative in August as it is not matching with its performance. Though most of the NBFIs are in the critical zone due to high NPL, it is not reflected in the spread as negative, "proving" they are highly efficient in business operation.

The Bangladesh Bank will now calculate the weighted average lending rate by including the interest rate charged before loans turned default.

Explaining the change, the central bank's Executive Director and Spokesperson Md Mezbaul Haque said the previous calculation was wrong as a big portion of loans that went defaulted was kept out of the calculation. 

"As a result, the lending rate and the spread showed low which was not matching with the market rates," Mezbaul Haque said.

He said the statistics department's collected data from banks was miscalculated which distorted weighted average lending rate and spread data of banks and NBFIs. 

Such distorted data was misleading as the regulator was publishing those data officially, he added. In this context, the central bank initiated a correction in calculation of weighted average lending rate.

The newly calculated lending rate for non-bank financial institutions jumped by 3.29 basis points to 11.47% in August from 8.18% in July, according to Bangladesh Bank data. 

As the lending rate rose, the spread also increased to 3.39% from 0.16%. If the spread was calculated based on the previous formula, the spread would be negative in August, a central bank official said, requesting anonymity.

Low spread indicates the ability of financial institutions to lend at a cheap rate. In reality, non-bank financial institutions are lending at double digit as their lending cost is high due to higher default loans, the official said.

Therefore, the Bangladesh Bank has sent a new format to all scheduled banks for adding information of interest rate charged on default loan amount to calculate weighted average lending rate. 

The new lending rate calculation will be implemented from December, according to the letter sent to the banks. The weighted average lending rate is calculated at the end of every month.

In September, the weighted average lending rate for banks was 7.83% when market rate crossed 10%. Moreover, the spread was 3.26% when the regulatory requirement for maintaining spread was 4%.

However, the Bangladesh Bank lifted the requirement of maintaining a certain spread limit for banks in November 2023 on the ground that the newly introduced lending rate formula SMART (Six Months Moving Average Rate of Treasury Bill) will automatically control the unusual hike of lending rate in the market.

In the circular, the central bank said SMART was introduced with a view to ensure efficient loan management. So, there is no more need to maintain the spread limit mandatorily but banks have to continue to report the central bank about its spread.

The Bangladesh Bank introduced the new lending rate formula from July under which banks will lend adding a maximum 3.5% with SMART rate.

How distorted forex reserve data misled regulator

Distortion in weighted average lending rate calculation is not the only case, the central bank did the same thing in case of foreign reserve calculation for which the country is now paying a high price.

The central bank ignored the international standard in calculating forex reserves for 12 years and overstated foreign exchange reserves by $7 billion.

With this inflated reserve, the central bank built up an export development fund from the reserve and provided $2 billion for infrastructure development projects. 

However, under the pressure of the International Monetary Fund (IMF), the central bank started to follow the new reserve calculation as per international standard called BPM-6 manual.

With this new calculation starting from July this year, nearly $7 billion were excluded from gross reserves. 

Besides, the central bank also stopped lending from reserves through the export development fund and providing funds to development projects after adopting the new calculation as the new reserve figure was not adequate for spending in other fields.

Country's gross reserve was recorded at the highest $48 billion in August 2021 as per previous calculation. But as per new calculation actual gross reserve was highest $40 billion during that time which means central bank overstated $8 billion reserve. 

The gross reserves came down to $19.16 billion on 13 December this year, according to Bangladesh Bank data.

On the other hand, the IMF under its $4.7 billion loan package programme, has set a target for net reserve as it considers that net reserve is instantly available to use when gross reserve is included with liability.

The country's net reserve came down to $15.9 billion in October, according to the IMF.

However, in a statement sent to The Business Standard on 28 November, the Bangladesh Bank claimed the published net reserve figure of $15.9 billion was misleading. 

It also claimed that the country's gross reserve was $25.16 billion and as per BPM-6 reserve was $19.52 billion. 

The reserve amount as per BPM-6 is entirely usable, according to the statement. 

However, this claim contradicts the IMF as the multilateral lender considers the net reserve as a usable fund and it sets the target on maintaining net reserve instead of gross reserve.

Following the first review of the second installment for its loan package, the IMF has adjusted the net foreign exchange reserve ceiling for December to $17.78 billion, revising down from the previous target of $26.8 billion. 

The central bank in its statement also distorted data mentioning the reserve figure at $25.16 billion based on the previous calculation, which was invalid after adopting the new BPM-6 calculation.