Big borrowers real beneficiaries of lending rate cap: BB study

Infographic: TBS

Lower lending rate amid the current interest rate cap has been a boon to "rich" industrial borrowers as this group of customers has received a lion's share of total private sector credit disbursed by the scheduled banks, a Bangladesh Bank study has found.

"Evidence shows that the interest rate on the large industries is lower than the agriculture and the CMSME, which raised concern that imposing cap may be benefiting rich more than the small and medium borrowers," says the study report, entitled "Impact Assessment of Interest Rate Caps and Potential Policy Options: Bangladesh Perspective".

The report also observes that there is an uptrend in inflation in recent times which might necessitate the lifting of the interest-rate caps, as savers' deposit incomes are devoured by high inflation.

It recommends that in order to strengthen the monetary transmission channels, the Bangladesh Bank may start to target the short-term interest rates, specifically, the call-money rate, as practised in peer central banks in the region.

The Bangladesh Bank has already hinted at tightening the monetary policy stance by increasing the repo rate. 

Following the global trend of the historic high inflation rate and recent price hikes of fuel oils in the domestic market, further tightening of monetary policy may be required in the coming months, and without moving or removal of interest rate caps, any policy rate hiking seemingly may not be effective to transmitting the signal to the real sector of the economy, says the report.

The report also notes that the impact of the interest rate restrictions on the borrowers may be asymmetric, which will hamper the broad objectives of the interest rate cap. Therefore, the central bank needs to be vigilant not only about the quality of the loans but also about the quality of the borrowers.

The study is authored by Bangladesh Bank Executive Director Md Julhas Uddin, and Director and Joint Director of the Research Department of the central bank Sayera Younus and Tarek Aziz.

Sayera Younus told The Business Standard that the Bangladesh Bank has increased the repo rate to give a signal to the economy that the central bank is in a contractionary mood. 

"People will borrow less if the interest rate caps are lifted and the lending rates go up. As a result, inflation will decrease due to reduced economic activity. But at the same time, economic growth will also slow down to some extent."

Mentioning that a large amount of investment in the industrial sector creates more employment, she said this type of loan growth cannot be called bad at all. 

"On the other hand, banks' operating costs for lending to the agriculture and CMSME sectors are also slightly higher than for industrial loans, so the interest rate is also high," she explained.

Meanwhile, in a recent meeting with the central bank, the International Monetary Fund (IMF) asked for lifting the existing lending rate cap and leaving the country's foreign exchange market to a free-floating exchange rate system. 

The central bank told the IMF that it was considering leaving the dollar rate to the market soon.

According to the Bangladesh Bank's study report, the objective of the study was to examine the current status of the lending and deposit rates after imposing the 9% cap on the lending rates and 6% on the deposit rates effective from 1 April 2020 and its impact on the macro- and bank-specific variables.

Data obtained from the central bank shows at the end of FY20, the total loan disbursements by banks to their "rich" customers in the industrial sector was Tk3,86,390 crore, which climbed to Tk4,81,520 crore at the end of FY22. 

On the other hand, during these two years, loans to small and medium borrowers in the agricultural sector increased by only Tk6,080 crore, and in the CMSME sector by Tk22,640 crore.

The Bangladesh Bank report says the relationship of the lending rate cap with non-performing loans is also significant and positive as the interest rate caps have helped to bring down non-performing loans.

Bangladesh's experience shows that although banks are charging lower interests, they are enjoying profits at the cost of lower deposit rates.

Empirical results, however, show that there is an inverse relationship between real private investments and real lending rates. The profitability measures in terms of Return on Assets (ROA) and Return on Equity (ROE) show no sign of deceleration of profits after the reduction of lending rates, rather they increase.