Rising inflation new headache for bankers

At a time when banks are already under pressure of managing default loans in the post-pandemic era, rising inflation has become a new headache for bankers as it will eat up their profit.

Bankers have to revise up deposit rates in line with the surging inflation, according to the Bangladesh Bank's cap on interest rate for savers.

As inflation inched near 6% in October with global trends hinting further rise in the near future, bankers are worried about shrinking profit margins as they do not have the scope to increase interest rates on loans due to the 9% lending rate cap set by the central bank.

If inflation goes up to 6%, deposit rates will have to be revised up, which will give banks only a 3% business margin.

Amid rising deposit costs, lending rate also surged by 2% to 3% in the last two months, according to bankers.

Mohammad Shams-ul Islam, managing director and CEO of Agrani Bank, said if deposit rate goes up in line with inflation and the lending rate remains the same, the balance sheet of the bank would not grow.

"So, it is challenging for us, because the cost of funds will be high. But the banks have an option to choose treasury bonds, as the bond rate is quite good now," he added.

On the other hand, the industry also has the potential for significant growth in the private sector credit owing to huge domestic demand and recovering exports due to the sudden demand spike in foreign markets.

The lending rate cap, however, might be a crucial factor for the overall profitability of the banks.

In this regard, President and Managing Director of Bank Asia Md Arfan Ali said to The Business Standard that to some extent, this inflationary pressure may create a negative impact on the balance sheet of the banking industry, which has a low-profit margin. But still, the lending rate cap was a safeguard for small entrepreneurs.

Earlier last year, the central bank had set a 9% lending rate cap from 1 April 2020. As a result, banks went for a massive cut in deposit rates to adjust to their costs.

Terming inflation a temporary price hike, Managing Director and CEO of Mutual Trust Bank Limited, Syed Mahbubur Rahman, said oil price in the international market was falling. "Therefore, I do not think this sudden inflation would be a big challenge for the banking sector."

He said initially the banks may incur some loss, but in the long run the deposit and lending rate cap would protect customers' rights. "As professional bankers, we may have a profit-making tendency from the industry. But in this post-pandemic era, as a human being, I am standing with consumer protection first," he said.

Though the inflation was temporary, the sudden surge has led to customers asking for more lending. To strengthen economic recovery, banks have to ensure more credit flow to the market that will lead to a healthier industry, the senior banker added.

Jamuna Bank's Managing Director and CEO Mirza Elias Uddin Ahmed said inflation in the economy was related to demand. And the temporary inflation prevailing in the economy was mostly demand-push inflation. Some elements of cost-push inflation were also present, but this was mostly artificial inflation in the market.

When imported raw materials are turned to finished goods, then the foreign exchange flow will return to normal and the rate of dollar will also be regularised, he added.

Despite having long-term deferral for the loan repayment of stimulus, the central bank may launch special products like bonds. It might be the 10-year instruments, then the borrower would get time for the repayments. For instance, in the first five years they will pay interest only and pay everything in the last five years. It will increase the efficiency of the economy and the banking industry will face fewer challenges also, Mirza Elias said.

"In a period of crises, we see such practice in other countries. After releasing this kind of product, the deferral would go out of context. However, without having such an instrument, finishing off deferral could create a problem. So the banking industry should be careful with its overall operations." 

In this connection, the former governor of the Bangladesh Bank Salehuddin Ahmed told The Business Standard, that the banking sector would not face significant pressure from the sudden inflation, but if it becomes a hindrance for the business environment, then it will create pressure on banks.

If production rises, including agricultural production, then in the long run inflation would not be a problem. But, regular supply of products must be ensured, which will create employment and reduce any sort of pressure on the economy.

Stoking fears of a liquidity crunch, private sector credit growth, which remained in a slump during the pandemic and amid the pressure of interest rate capping, jumped to 9.44% in October, the highest in the past one year.

The spike was the result of rising demand amid a resumption of economic activities. Credit growth had dipped below 9% in October last year and hit its lowest of 7.55% in May this year.

The demand for loans, however, steadily ticked upwards from June, after movement restrictions were lifted. It climbed to 9.44% in October, according to data from the Bangladesh Bank.

To meet the huge demand for credit, Bangladesh Bank has recently decided not to mop up any money from the market as a part of its efforts to ease the ongoing liquidity crunch in the banking sector.

What the economists say

Economists, taking aggregate demand into account, are suggesting to think about the overall economic and banking policies taken by the regulator, focusing on how to rationalise the situation in line with economic activity, as the inflation continues to rise.

AB Mirza Azizul Islam, economist and former advisor to a caretaker government, told The Business Standard that when the inflation is rising, depositors will not be eager to deposit money in banks as they fear losing capital amid the fluctuation. This mostly hits the banks' deposit growth.

Under these circumstances, to maintain the advance deposit ratio, the lending capacity of the banks will go down.

Though in recent times the lending rate has jumped slightly, still it is not up to the mark. So, the banking industry is going to face crises and now the regulator should think about the interest rate obligation, and whether it will continue or not.

Speaking to TBS, Dr Ahsan H Mansur, executive director, Policy Research Institute, said, "I have never seen deposit rate being adjusted to inflation rate. At the same time we have a lending rate cap also. Now, if the inflation goes to 8 or 9 percent, what would be the situation then?

"The regulator has no control over short-term inflation. Now, for the money market and exchange market, Bangladesh Bank should not distort the long term trend. Day to day, the volatility may be controlled but not the broad trend," he added.

In this regard, central bank spokesman Executive Director Serajul Islam said, "This inflation measurement is for the very short time. So, I don't think that it can hamper the banking industry at all."

And the spread between the inflation rate and the lending rate cape is not also insufficient so far. Rather, apart from lending and all banking operations, the banks should now concentrate on reducing non-performing loans to enhance the overall health of the banks, he added.

Default loans in the banking sector hit Tk one lakh crore in September, according to the Bangladesh Bank data.

Raising concerns about the health of the banking sector, Fitch, the global rating agency, said the reported default loan is likely understated because of an extensive loan moratorium during the pandemic.

The rating agency fears that default loans will increase significantly after the ongoing loan moratorium facility is lifted, putting the banking industry under stress.

The Bangladesh Bank extended the moratorium to 31 December this year in response to a request from businesspeople.

In August, the central bank had set a floor on deposit rates for the sake of depositors as they were getting an interest return lower than the inflation rate, which erodes their purchasing capacity.

From now on, the interest rate of term deposits must not be less than that of inflation. And with the rising inflationary pressure, the banking industry is spending more against deposits, as per the Bangladesh Bank circular.

In the circular, the Bangladesh Bank observed that most banks are offering lower interest rates for deposits than the inflation rate. As a result, savers are being affected and losing their purchasing capacity.