Borrowers save Tk9,400cr on lending rate cap

The lending rate cap helped borrowers save interest costs of Tk9,400 crore last year as banks lost the amount from their interest income.

Even though the interest income of the banking sector declined by 9.4% last year – the first year of imposing the lending rate cap – compared to a year ago, lenders were smarter in diversifying earning sources.

According to the Bangladesh Bank's financial stability report for the year 2020 released recently, the banking sector posted a 24.5% growth in non-interest income last year.

The interest rate ceiling and Covid-19 induced economic downturn coupled with restrictions on charging interest on accrued interest during the pandemic period might be some key reasons behind the drop in banks' interest income, observed the central bank in its report.

When their interest margin came down because of the lending rate cap imposed from 1 April last year, banks came out from lending dependency by focusing on investment tools like stocks and government securities.

The lending rate capping drew huge criticism in the market at the start, but the move appears to have brought about a win-win situation for both borrowers and lenders eventually.

After the implementation of the lending rate ceiling, borrowers could take out loans at 6-7% interests last year. Previously, banks used to charge double-digit interest rates on such loans.

The low interest margin compelled banks to emphasise quality lending and focus on investment. As a result, banks' investment in stocks increased by Tk4,100 crore in 2020 from the previous year, although the sector's consolidated exposure to the capital market declined by almost the same amount in the previous year.

On the other hand, the banking sector's investment in government securities grew by about 50% last year. After posting a negative growth of 11.5% in investment in government securities in 2018, banks started to increase the investment and registered a 44.3% year-on-year growth in 2019.

"The government's higher reliance on bank-based budget financing, safety and security along with liquidity offered by the instruments might have induced banks to invest heavily in these instruments. However, if these investments continue to soar, there might be a crowding out effect," said the central bank in its report.

The total investment of banks in government securities stood at Tk2.11 trillion at the end of December last year.

As private sector credit growth tumbled to 8% level after the outbreak of the novel coronavirus in March last year amid stagnant business expansion, banks preferred investing in risk-free tools – government treasury bills.

The interest rate of government treasury bills picked up to above 8% in June last year amid high borrowing by the government from banks when the interest rate of risky private-sector loans was 9%.

The high interest rate paid by the government contributed to banks' earnings.

The lending rate did not hamper the dividend of bank directors either, which is clearly evident from banks' cash dividend declarations for last year.

Out of 31 private banks listed on the Dhaka Stock Exchange, 22 have already disbursed cash dividends for 2020. Dividends declared by most of these banks for last year are higher than or similar to that of the previous year.

The total cash dividend payout by these banks stands at around Tk2,300 crore for pandemic-hit 2020, of which around Tk1,000 crore will go to directors' pockets.

However, depositors have been severely affected by the lending rate cap as their return became negative from bank deposits.

In this perspective, the central bank on 8 August this year issued a circular asking banks not to set interest rates on term deposits below the inflation rate. 

A decline in net interest margin caused banks' interest income to plunge last year, said Selim RF Hussain, managing director of Brac Bank.

He observed that private sector credit growth was low due to a slump in demand amid Covid-induced lockdown and movement restrictions last year, which also affected the revenue of banks.

Private sector credit growth was 8.4% last year, far below the monetary target of 14.8%.

Selim RF Hussain sees two major challenges in the coming days for the banking sector – first, an upsurge in default loans; and secondly, a further fall in interest margin due to deposit rate capping.

The amount of default loans has already started to rise following the lifting of forbearance, said the seasoned banker, adding that although many businesses have started to recover, there remains an uncertainty about a complete normalisation of economic activities.

Implementation of the deposit rate cap may affect banks' interest income this year as well, he assumed.

The deposit rate of Brac Bank, largest SME lender in the country, came down to 1% – lowest among private banks – following the implementation of the lending rate cap. However, the bank on 9 August revised up its interest rate in line with the deposit rate cap set by the Bangladesh Bank.

Other banks too have started to revise their deposit rates up as per the central bank's instructions.

The overall net interest margin of the banking industry declined to 1.4% last year from 2.1% in the previous year, according to the central bank's financial stability report.

Net interest margin is the difference between the interest income generated and the amount of interest paid out.

The stability report shows that state-owned banks experienced negative net interest margins last year after having a positive margin in the previous year.

The net interest margin of private banks declined to 1.9% last year from 2.8% a year ago.

Foreign banks too have witnessed a decline in their net interest margin, but their interest income rates are still better than others in the banking industry.

The interest margin of foreign banks decreased to 2.8% in 2020 from 3.6% in the previous year, according to the stability report.

"It is worth mentioning that the interest income of foreign banks was much higher compared to their interest expense, whereas the interest income from loans barely exceeded the interest expense on deposits for the state banks," the report stated.

The fall in interest income affected the total net profit of the banking industry. The total net profit of the banking industry declined by 33% to Tk4,660 crore last year, compared to the previous year.

"In order to maintain profitability and utilise their extra liquidity, banks opted for secured alternative, increased investment in government securities.

"However, to keep pace with the growth momentum and to ensure sustainable growth, banks need to utilise their increased deposit base and ensure smooth credit flow to the thriving private sector," stated the financial stability report.