Banks’ interest rate spread hits 41-month high in August

Highlights

• Interest rate spread in August stands at 3.33%
• 3% gap deemed standard
• The spread kept increasing after BB back out from capping fixed rates from July
• As six-month moving average rate of treasury bill rose to 7.20% at the end of September, the interest spread may rise further

Interest rate spread — the difference between deposit and lending rates — of banks hit a 41-month high in August at 3.33%, mainly due to banks having the opportunity to increase their lending rates. 

Experts say a spread of at least 3% is deemed to be required for any bank or non-bank financial institutions (NBFI) to be comfortable with running costs.

According to the latest data from the central bank, banks collected deposits at an average interest rate of 4.52% in August, which was 4.46% in July. These deposits were invested as loans at an average interest of 7.85%, 10 basis points up from July. The difference or interest spread between these two interest rates stood at 3.33%. The spread was 3.29% in July. Earlier in March 2020, the interest spread was 4.07% with average deposit interest rate at 5.51% and average lending interest rate at 9.58%.

A senior official of the central bank said that from April 1, 2020, the central bank capped the deposit rate at 6% and the landing rate at 9%. For NBFIs, it was 7% and 11% formally. Because of this, the banks and NBFIs could not exceed the fixed cap of deposit and lending rates. However, the new monetary policy unveiled in June this year lifted the cap on deposits with effect from July.

In the monetary policy, the Bangladesh Bank introduced the reference lending rate, known as "SMART" (six-month moving average rate of treasury bill), which are now being announced monthly through the central bank's website, with a margin applied for banks and NBFIs. In practice, SMART plus a margin of up to 3% are applicable for banks and 5% for NBFIs. However, the lending activities for CMSMEs and consumer loans may be subject to an additional fee of up to 1% to cover supervision costs.

SMART was 7.10% in July, which means banks and NBFIs have got the opportunity to charge a maximum landing rate of 10.10% and 12.10% respectively in August. Basically, this is why the banks increased the interest rate spread.

According to the central bank, SMART, which is on the upward trend, rose to 7.20% at the end of September. The increase suggests that the interest spread of banks and NBFIs may rise further in October.

Syed Mahbubur Rahman, managing director of Mutual Trust Bank, said as the central bank has given the opportunity to raise the landing rate, the profitability of the banks has increased, which is definitely good for the banking sector. "But our main concern is with default loans, it is constantly increasing. As a result, banks need to keep more provision." The banker commented that if the profit of the banks rises, the ability to keep provisions also increases.

A loan loss provision is an income statement expense set aside as an allowance for uncollected loans and loan payments. This provision is used to cover different kinds of loan losses such as non-performing loans, customer bankruptcy, and renegotiated loans that incur lower-than-previously-estimated payments.

The country's NBFIs witnessed a historic low interest-rate spread at 0.16% last July, which slightly increased to 0.19% in August.

According to the central bank data, NBFIs collected deposits at an average interest rate of 8.08% while the rate on loans stood at 8.27% in August. Consequently, the interest rate spread for NBFIs stood at 0.19% in August.

Kyser Hamid, managing director and CEO of Bangladesh Finance Ltd, told TBS, "Except for a few institutions, default loans are very high in most of the NBFIs. Due to increase in spread, the interest income of these institutions will rise slightly. As a result, their ability to keep provisions will increase. The rising Interest spread may help the sector to develop its profitability." However, if the default loan is not reduced, the balance sheet of these institutions will not develop much, he commented.