On the surface, Wednesday's decision looks like part of a nicely calculated and targeted approach to boost investment, as the finance minister hopes.
First the banks were allowed more funds through cutting their requirements of keeping cash with the central bank and lowering their advance-deposit ratio, and then in the proposed budget their tax was reduced.
So when the sponsors of the banks on Wednesday announced reduction of lending rates to a maximum of nine percent and capped deposit rate at six percent, it looked like a welcome move.
But beneath the surface, the announcement by the bank sponsors (we cannot call them owners as 70 percent of the shareholders are the general public) looks curious, questionable, scattershot execrable decision and, as experience shows, untenable that will further complicate the troubled banking system with knock-on effect on the economy.
It is curious because it beats the logic why sponsors should make a commercial decision of the banks instead of the professionals. How banks will run and make profit should be decided by the bank executives, the CEOs and their competent team of professionals who will weigh every aspect and make a decision.
There might be an answer to why the sponsors are calling the shots -- their intervention in the banks have left the institutions in pretty bad shape, evoking ire from every corner and so by making the decision they are now trying to take political advantage.
But the announcement of interest cut is at best a political show. Here is why.
The rebate in interest rates, if one follows the logic being dished out, comes from the extra profits that the banks will generate because of lowering of corporate tax. Does it make any sense? Is there really a transition mechanism between tax rate and interest rate? Does it mean if the banks are offered zero tax, their rates will come down to 2 percent or so? Not at all.
Because at least four factors are linked to interest rate of the banks -- cost of deposit, transactional costs, adjustable risk premium and profit.
In this case, only the profit factor was taken into account. The banks' transactional costs are high mainly because of non-performing loans or NPL in banking jargon. At 10.78 percent, Bangladesh has one of the highest NPL and this directly shores up the banks' transactional cost. On top of it, the banks are writing off loans as a standard procedure to keep their books clear -- so far Tk 48,192 crore loans have been written off as unrecoverable bad loans, Tk 3,502 crore in 2017 alone. These also spike costs and add to interest rates.
When the money that the banks lend out tend not to come back, the banks' risk premium is also high that marks up interest rates as well.
And finally, depositors will not put money into banks until they get a return higher than the inflation rate in real terms. Otherwise their money will shrink. So an attractive deposit rate also affects lending rates.
But Wednesday's decision seems to have discounted all these factors and rather focused on their rebate in tax and increase in profit. This is an untenable proposition, political in nature.
The announcement is untenable because of the inflation factor. Currently at 5.8 percent, inflation is set to increase in future because of depreciating taka and global trade tension. What incentive would a depositor get to put his money in a bank at 6 percent? Does it make sense that a depositor will simply sit and watch his money shrinkin the vault?
Dr Mustafizur Rahman, distinguished fellow at the Centre for Policy Dialogue, puts it this way: “The ceiling on savings will serve as a negative real interest rate for savers. The small and medium savers will get no incentive in real terms.”
In such a scenario, depositors will pull the money and invest elsewhere. But does he have any alternative? Actually few, especially if he is a small or medium saver. The capital market is anything but a regulated safe place. They may go for land and gold. But for a small saver both are way beyond easy reach.
The national savings certificates are the only alternative where he gets about 11 percent return. So banks will run dry when savers shift their money. What will then happen to the government's target of lowering borrowing from savings instrument next year to reduce loan servicing burden?
But if the government cuts that rate as well to generate funds for the banks the small savers will sit high and dry. Without any social security system and rising healthcare cost, the predicament of the middle class is palpable.
As we talked to bankers, their feeling of uncertainty after the decision is discernible.One CEO said his bank has over TK 2,000 crore in fixed deposits mostly from government bodies taken at over 10 percent interest rates and there is no change in his NPL. With such high transactional costs, he knows no way of curbing rates in line with Wednesday's decision.
If that is the situation, the rate cut announcement sounds hollow, if the past is any indication to go by. In the face of pressure, the banks had reduced lending rates to single digits in 2017. Not before long, they had to reverse their decision.
The same day that the bank sponsors had announced rate cuts, Finance Minister AMA Muhith has expressed the hope that it would help investment.
But the share of interest rate in cost of production is so miniscule that it would hardly have any impact. For the garment industries it accounts for less than 1 percent and for other industries it is not beyond 3 percent.
Dr Mustafizur Rahman also points this out when he told The Daily Star that there is more than one element to investment, and interest rate is just a small part of it. Interest rate given its total share in business expenditure will not stimulate investment.
“Without addressing the deeper underlying problems of malgovernance in the banking sector, this type of monetary management by diktat will accentuate rather than resolve the problems,” he observes. “Also, in view of the provisioning requirements and efficiency level, majority of banks will not be able to maintain the suggested spread.”
Given it's an election year, do we have a case of politics playing havoc with economy?