Are you losing money by keeping it in the bank?

Savers just cannot catch a break. Because of persistent low interest rates, anyone looking for decent returns has had a tough time for the past one year. Most of the savings accounts, for instance, don't even top a five percent annual yield.

This is because the regulator—Bangladesh Bank (BB) has capped the deposit rates at 6 percent.

According to the BB, the deposit rates have fallen throughout 2020, from 5.69 percent in January to 4.73 percent in October. In such a scenario, depositors have made no real gain from interest on deposits.

The real interest rate, which is a nominal interest rate adjusted by the rate of inflation, is an indicator of real growth. If the interest rates are lower than the rate of inflation, a person's savings could lose purchasing power over time.

At the end of October, the 12-month average rate of inflation was 5.77 percent, while the rate of deposit was 4.73 percent. This indicates that the real interest rate on deposits during October was -1.04 percent.

Theoretically, it means, if a depositor were to deposit Tk 1,000 in a fixed deposit account, he would earn interest amounting to Tk 47.3. However, due to heightened inflation, the purchasing power of his money would fall by Tk 57.7.

Despite having a total nominal balance of Tk 1047.3 now, the real value of his deposit is approximately Tk 990, i.e. lower than before.

This means that due to low deposit rates and higher inflation, the real value of the deposit has decreased by more than 1 percent.

The situation is far worse if the 15 percent tax on interest earnings is factored in.

Is there any better alternative?

In such a scenario, it is very likely that depositors will transfer funds elsewhere. Doing so would adversely impact money supply, the spillover effect of which will hamper private sector credit availability and growth. 

With the government's increasing lending from the private sector, any shortage in liquidity in the private sector will make crowding out effect much more pervasive.

The reason why slashing deposit rates may be harmful is the National Savings Certificate. The NSC is a dominant alternative to traditional banking products. It offers both flexibility and higher returns.

In stark contrast, while deposit rates have been capped at 6 percent, interest rates on NSC remain nearly unchanged.

During 2020, NSC interest rates ranged between 9 percent and 11.76 percent on average, depending on maturity, type of scheme, and time of encashment, making NSCs a much better alternative to fixed deposits.

The reason the interest rate crisis has the ability to adversely impact money supply is because deposits are a primary component of money supply. 

According to BB data, time Deposits is the most significant component of Money Supply (M2). As of October, Time Deposits accounted for 77.6 percent of total M2. This elucidates how any major impact on deposits due to interest rates can be detrimental for liquidity.

At the end of Q1, 2020, 81 percent of all deposits accounted for private sector deposits (Tk 97.7 trillion), while 46 percent of all private sector deposits were fixed deposits (a type of time deposit).

The largest depositor segment in the private sector is the household sector, in which service holders, industrialists, businessmen and housewives account for the majority of the deposits. 

One common attribute amongst these depositors is the preference for interest bearing deposit schemes. Of the Tk 63.7T deposits owned by the individual customers, 44.4 percent are fixed deposits, and 34.5 percent are savings deposits. (Q1,2020)

Currently, 34.6 percent of this user group's deposits are held as FDs with tenure less than 6 months. In fact, 77.22 percent of all fixed deposits held by this user group have maturities less than three years. 

These depositors, who drive private sector deposits, have been enjoying interest rates between 6.71 percent to 8.52 percent previously. Therefore, the drastic move to cap rates discourages savings and threatens money supply.

What is the implication?

World Bank's Global Economic Prospects Report states that many Emerging Markets and Developing Economies (EMDEs) have capped interest rates or prohibited reclassification of outstanding loans during the pandemic. The debt accumulated in response to such policies will take a toll on the EMDEs.

To service this accumulated debt, a significant amount of financing will be required. As a result, the requirement of funds may rise drastically. 

Ultimately, a central bank intervention is inevitable, whereby the central bank will have to inject money into the economy or remove the interest rate cap to allow the law of supply and demand to maintain its natural equilibrium.

The former decision will increase inflationary pressure. The latter will lead to crowding out effect. Either way, the brunt of the interest rate crisis both in the short and long run is to be faced by the banking sector or depositors or both.

Currently, risk averse depositors are either transferring funds to NSCs or scrambling for whatever nominal gain they can make by depositing in fixed deposits. Depositors with higher risk tolerance have invested in riskier assets such as the stock market, which had posted a 21 percent return in 2020. However, stocks are a high-risk asset, so it is no alternative to fixed deposits or NSCs.

However, crises present the best of opportunities. The central bank has been mulling over the securitization of government securities (G-Secs), such as T-Bonds, T-Bills. Currently, these securities are sold in the OTC (over the counter) market. Therefore, they are not very liquid in nature.

Securitization would allow these G-Secs to be listed on the DSE, allowing investors to buy and sell these G-Secs independently and in real time.

As wide scale vaccine rollouts are expected throughout the year, economic activity is expected to inch closer to pre-covid baseline, and so is the demand for funds. Therefore, the Central Bank must act quickly to avert the looming interest rate crisis and ensure sustainable transition into a post pandemic economy.

Abrar Ahmed Photo: TBS Illustrations