Imbalanced money market causes banks to shirk private sector lending

The high interest rate on risk-free investment tools and the low rates of return on risky loans have created a serious imbalance in the money market, causing banks to steer clear of the private sector.

This has also exposed the inefficiency of the Bangladesh Bank in controlling money movement. 

As money tends to flow towards high returns, the money from banks is going towards risk-free investment while the private sector is being left high and dry.

This is evident from the sluggish private sector credit growth, which came down to single digits in November last year and ended the last fiscal year with a downward trend.

The credit growth was 8.61 percent in June, far below the monetary target of 14.8 percent set for the last fiscal year, at a time when the banking sector is awash with excess liquidity to the tune of Tk1.39 lakh crore. 

Excess liquidity has been increasing as banks are investing more in government bills and bonds instead of lending to the private sector.

The Bangladesh Bank, in its Financial Stability report for 2019, admitted that banks preferred to invest in government securities due to the high interest rate instead of lending. 

In the report, the central bank raised concerns that high bank borrowing and banks' preference to invest in risk-free government securities could crowd out credit for the private sector.

Against this backdrop, the Bangladesh Bank is set to announce its monetary policy for the current fiscal year at the end of this month.

When contacted, BB Executive Director (Research) Dr Md Habibur Rahman said the imbalance in the money market had been going on for a long time as interest rates were not market-driven. 

"The Bangladesh Bank is now trying to rationalise the interest rates to encourage banks to go to the market," he said, adding that the issue would be considered in the new monetary policy to bring back balance to the money market.

How did the money market get imbalanced?

To balance the money market, the central bank diverts money flow to risky sectors by setting risk premium rates based on risk-free rates.

The interest rate of government bills, bonds and savings instruments, repo rate, call money rate, lending rate and deposit rate all determine the direction of money flow.

But the interest rates of all these instruments seem to be moving in a completely opposite direction to what economic theories suggest.

For instance, the interest rate of government treasury bills and bonds – considered risk-free investment tools – more than doubled in the last one year.

In December 2018, the interest rates of one and two-year-tenure government bills and bonds were 3 to 4 percent, which jumped to above 8 percent in December last year. In May, it declined, but still stayed above 7 percent.

The rate is supposed to be down as the market is awash with excess liquidity and banks have a huge demand for investing in government bills and bonds. But high government borrowing has kept the rate upward. 

The government borrowed Tk72,246 crore in the 2019-20 fiscal year – the highest borrowing in a single year. 

As risk-free rates increase, the interest rate for risky investments is also supposed to move in the same direction. But that did not happen because of poor market mechanisms; the government imposed an interest rate cap on lending to the private sector.

Interest on private sector lending, considered risky due to chances of default, were fixed at 9 percent from April this year, although it was above 11 percent earlier.

As a result, money is flowing to government treasury bills and bonds instead of to the private sector.

"The size of the latest auction of 2-year T-bills [treasury bills] a couple of days ago was more than Tk4,500 crore – much bigger than any of the recent auctions," said Shahidul Islam, CEO of VIPB Asset Management Company.

He said that despite yield coming down sharply, the entire issuance was taken up by banks or their clients. The Bangladesh Bank took nothing. Therefore, the banks have a very strong appetite for government securities, which means they do not have much appetite for lending to the private sector. 

"Growth of private sector credit will remain very low unless the Bangladesh Bank aggressively purchases the upcoming issuances of government bonds," he added.

The imbalance in interest rates on bank deposits and government savings instruments has also reduced bank deposits.

Interest on savings instruments, another risk-free investment tool, remained above 11 percent.  

In the first 11 months of the last fiscal year, the government's net borrowing from national savings schemes stood at Tk11,011 crore, which was 92.34 percent of its revised target.

According to the Department of National Savings, the gross sale of savings certificates stood at Tk3,227 crore in May this year.

On the other hand, the government instructed banks to keep deposit rates at 6 percent as part of its plan of implementing the lending rate cap. 

When inflation is above 5.5 percent, the 6 percent deposit rate does not give any return to depositors. Moreover, there is no risk premium on the deposit rate since the banking sector is in serious trouble with loan scams and high default loans. 

As a result, depositors are switching their investment from banks to savings instruments. 

Deposit growth saw a sharp fall of 8 percent year-on-year in April, which was 12.59 percent in January, according to central bank data.

Total deposits of all banks in the country decreased by Tk25,600 crore, to stand at Tk1,228,000 crore at the end of April this year from Tk1,253,600 crore in January, according to Bangladesh Bank data.

There is also an imbalance between the call money rate and the repo rate.

A repurchase agreement (repo) is a form of short-term borrowing for dealers in government securities. In the case of a repo, a dealer sells government securities to investors, usually on an overnight basis, and buys them back the following day at a slightly higher price. 

The Bangladesh Bank fixed the repo rate to give a signal of interest rate movement in the call money market. If the call money market rate goes up due to a cash crunch in banks, the central bank supplies money through repo. 

The call money market is supposed to reflect the real liquidity situation in the market. 

But in reality, the Bangladesh Bank suppresses the call money rate movement through artificial interference. 

When banks borrow heavily in call money, pushing up interest rates, the Bangladesh Bank instructs banks not to do it. 

As a result, the call money rate always remains stable.

Though the call money rate is below the repo rate, the central bank is supplying money to the banks, which is a hint that the banks cannot play in the call money market.

The average interest rate in the call money market has been hovering at around 3 to 4 percent although the Bangladesh Bank has been supplying money through repo at 5.25 percent. 

If the call money market is allowed to move freely, the interest rate would go up, said a senior executive of the central bank.

"That would be because the inter-bank repo rate is now above 7 percent," he said. 

The money market has remained imbalanced for a long time as the Bangladesh Bank never let the market function freely, he added. 

He said the central bank was supposed to balance the money market through monetary policy but it had always taken an accommodative approach to managing the market, meaning it had no long-term projection about where it wanted to see the interest rates or inflation to go.

On the contrary, it took measures on a short-term basis based on the current situation. Moreover, the central bank does not have its own projection about interest rates or inflation – it makes adjustments with fiscal policy. 

"The imbalance in the money market is a political economic problem, not a monetary management problem," said Dr Ahsan H Mansur, executive director of the Policy Research Institute of Bangladesh.

"That is because the government wants to have higher rates in the instruments, which are risk-free, to serve a well-off segment of people," he said.

Mansur stated that there was no market-based policy in Bangladesh. Everything, as he puts it, is fixed by the government. 

In the new monetary policy,the Bangladesh Bank would have nothing to do to bring about a balance in the market as the government had imposed a rate cap on lending, preventing the market from adjusting with the movement of other rates, he opined.