Lending rate cap to be lifted in June

The Bangladesh Bank has decided to introduce a benchmark lending rate, also known as a reference rate, lifting the current 9% rate cap in the following monetary policy, which will be announced in the third week of June for the next fiscal year.

The decision was made at a monetary policy committee meeting held on Sunday at the Bangladesh Bank head office. The meeting was presided over by Governor Abdur Rouf Talukder.

The central bank is preparing a mechanism to calculate the benchmark lending rate as prescribed by the International Monetary Fund (IMF) as part of its $4.7 billion loan approved in February, said a senior executive of the Bangladesh Bank.

Mezbaul Haque, executive director and spokesperson of the Bangladesh Bank, told The Business Standard that the decision on the benchmark lending rate cap would be announced in the next monetary policy when the lending rate cap will be lifted.

He said the committee also decided to introduce a policy interest rate corridor and new reserve calculation following the Balance of Payments and International Investment Position Manual in the upcoming monetary policy.

An interest rate corridor guides short-term market interest rates towards the central bank target/policy rate. It consists of a rate at which the central bank lends to banks (typically an overnight lending rate) and a rate at which it takes deposits from them (deposit rate).

With these three significant policy changes, the Bangladesh Bank will enter a new interest rate regime, adopting the new monetary policy model suggested by the IMF, said another senior executive of the Bangladesh Bank.

Introducing the benchmark

The proposed benchmark lending rate will be the reference rate for commercial banks in setting interest rates for borrowers.

It will come into effect in July, said the Bangladesh Bank senior executive.

For instance, the central bank will announce a single lending rate based on various existing rates like government treasury bills, bonds, and inter-bank rates. Banks will use this as the reference rate.

If the benchmark rate is 7%, commercial banks will set their lending rate accordingly, adding some premium of around 3%. The benchmark rate will be changed every month based on market demand.

When contacted Ali Reza Iftekhar, managing director and CEO of Eastern Bank Limited, said, "We have heard about the benchmark lending rate mechanism through which the lending rate cap will be lifted. This new interest rate regime will be good for the financial sector as banks will get a space for the price adjustment."

He added that if the reference point for the benchmark lending rate is calculated based on bond and inter-bank rates, it will be accepted as those rates are stable.

The government bond rate for a 20-year tenure is 8.75%, whereas a one-year tenure bond rate is nearly 8%.

On the other hand, the short-term treasury bills rate for 30 days is nearly 3%, according to Bangladesh Bank data.

Inter-bank repo rate – at which banks borrow from each other for a short term to meet cash shortages – came down to 6% in March, down from above 8% in January, central bank data shows.

The money rates indicate that the new benchmark rate is likely to be in the single digits if the lending rate cap is lifted in this current scenario, said a senior executive of a private bank.

Why Bangladesh entering a new interest rate regime

The IMF has suggested that the Bangladesh Bank go for a flexible interest rate targeting-based monetary policy, shifting from its monetary targeting framework as the existing model has been unable to check inflation through money supply targets only, amid an onslaught of external factors.

The IMF mission came up with the suggestion when visiting Bangladesh in November last year as part of a discussion over the terms and conditions of a prospective $4.5 billion loan sought by the Bangladesh government.

The central bank agreed to transform its monetary policy framework gradually by 2026.

The IMF suggested lifting the lending rate cap and going for a new monetary policy framework, which the Bangladesh Bank agreed to.

On the suggestion of the IMF, the central bank will set a maximum and minimum limit for the policy rate, known as the interest rate corridor. According to central bank officials, the money supply will be controlled in line with inflation through this.

New reserve calculation from June

The Bangladesh Bank disclosed its new reserve position per the IMF formula in June.

The IMF set the floor on net reserves at $24.46 billion for June when the lender will conduct the first review of the performance criteria of the central bank.

The net reserve will have to be calculated according to the new formula prescribed by the IMF. According to the central bank data, Bangladesh will show a $19 billion-plus net reserve if the new formula is applied.

This net reserve amount is readily available for intervention in the foreign exchange market.

The Bangladesh Bank has a gross reserve of $31.28 billion as of 16 March. But this figure is not acceptable to the IMF as the lender says some components must be excluded from the gross reserve.

As per the IMF formula based on the Balance of Payments and International Investment Position Manual, the Bangladesh Bank will have to exclude foreign currency loans to local banks, known as the Export Development Fund (EDF), which is now $5.5 billion, deposits with state-owned local banks, deposits with the IDB Group, fixed-income securities below investment grade, a loan to Sri Lanka and other foreign currency assets in non-convertible currencies, which total $2 billion of the gross reserve.

The IMF says the central bank must also exclude the reserve-related liabilities to estimate the net reserve. Bangladesh's current reserve-related liabilities amount to $4 billion. The net reserve will be $19 billion-plus if this amount is excluded.

The IMF introduced the BPM6 manual in reporting the reserve and balance of payment in 2012 under its Safeguards Assessments agreement, which applies to all members of the Fund.

Introduced in 2000, the Safeguards Assessments are diagnostic reviews covering five key areas of control and governance within central banks, including the external audit mechanism, legal structure and autonomy, the financial reporting framework, internal audit mechanism and the internal controls system.

The IMF conducts its Safeguards Assessments mission every 12 years, as the policy's main objective is to mitigate the risks of resource misuse and data misreport.

Following the launch of BPM6 in 2012, the Bangladesh Bank adopted it for the balance of payment reporting but ignored the latest manual for reserve calculation. At that time, Atiur Rahman was the governor.

Therefore, the banking regulator continued forex reporting per the BPM5 manual, which helped the central bank management show higher forex reserves, prompting the government to use it for different infrastructural projects.