Interest rate reduction: the good, the bad and the ugly | The Daily Star
12:00 AM, February 25, 2020 / LAST MODIFIED: 02:20 AM, February 25, 2020

Interest rate reduction: the good, the bad and the ugly

The news that the Bangladesh government is going to reduce the rate of interest of bank loans has, in general, been considered to be a positive one by businessmen. At the same time, it has not been received as favourably by depositors, since the rate of deposits will now also be reduced. The term is already well-known in the banking sector as 9 and 6—with the highest borrowing rate being 9 percent and the highest deposit rate being 6 percent. However, it is true that a reduction of the rate of interest has multifarious outcomes which can positively affect the economy, if it can be controlled by the government.

In our banking sector, loan default is a huge cause of concern, one that we are failing to control. Think-tanks of our country have found that higher rates of interest are one of the main problems that are leading to loans becoming stuck, allowing borrowers to become defaulters. Additionally, high rates of interest have also increased the cost of investment as well as the cost of production, leading to a situation where we cannot compete in the international market, or even in a local market that is saturated with international products. High rates of interest are also responsible for making good businessmen reluctant to take loans, which results in the negative growth of industrialisation. Inflation is another factor that tends to increase due to high rates of interest. As a result, a reduction of the rates as a solution to these problems is a good step and is likely to have positive impacts on the economy.

On the other hand, depositors are worried about where they will invest their money in the current context. There are many people, especially retired persons and repatriated wage earners, who mainly depend on the income from interest and are the biggest losers of the new policy. This is because a reduction of the rates of interest will reduce their income from said interest, which may reduce the buying power of these people. To meet this income gap, they may choose to withdraw their deposits or investments. As a safe investment, people used to opt for different government savings certificate, or different attractive deposit schemes of banks and other financial institutions which give high rates of interest. Now this opportunity will come to an end, once the rates of interest reduce.

The government has already changed the rules for purchasing savings certificates, resulting in a drop in the sale of savings certificates in the last couple of months, even though the rate of interest was still favourable at that point. If the rates of interest of different savings certificates are also reduced, their sales may be reduced even further. Recently, different scheme deposits run by the Post Office have also been reduced drastically to preserve the liquidity of banks. While there is speculation that the government may not fix a bar for the rate of interest of individual deposits so that people are not reluctant to deposit in banks, this cannot be considered to be particularly good news for depositors yet. 

People always tend to look for alternative sources of income when the existing source of income is not sufficient. Due to the reduction of rates of interest of banks, people may try to find other different sources of safer income, which could lead them straight into the hands of fraudsters, particularly if they are not well-informed on financial matters. The ugliest thing for the reduction of rates of interest is that in Bangladesh, we have the sore experience of observing the growth of different illegal organisations that attract people by offering illusory profits or interests by investing in their organisations. These tend to be different multi-level marketing companies, unauthorised illegal investment companies, online illegal investment companies, different illegal unapproved co-operative societies etc. Sometimes, these organisations can operate their businesses very openly so that people are bound to believe them and invest their savings in the hopes of receiving high profits, only to finally lose all their deposits in a bad investment. Government agencies must be vigilant and ensure that such organisations cannot now attempt to fill the gap and entice people into investing in their fraudulent activities. The government has the responsibility to make people aware and provide the education necessary, starting from the union level, through different campaigns. We must also all be conscious of these matters, exercising caution and doing the proper research before investing any money anywhere.

An alternative source for small investors is the capital market, where they may invest their money in lieu of the banks. However, due to the unstable behaviour of the market, especially in recent times, the general people still find it difficult to put their faith in it. While there are hopes in certain quarters that investment in the capital market will increase as a result of lower interest rates, this loss of faith in the market may stop lower interest rates from having this desired effect. Therefore, the government as well as the Security Exchange Commission have a role to play here in making the market stable and more trustworthy. The government can encourage the building up of mutual funds so that ordinary people who are not experts in the capital market can still invest their money in mutual funds with minimum risks.

It is true that higher interest rates are an impediment for smooth economic growth. The Bangladesh economy, despite all odds, is still booming and is now currently on the path to becoming a developed economy of a middle-income country. Hence, low rates of interest in such a context is to be expected. Since we are not yet used to single digit rates of interest in this country, the going may be rough for a while, as all involved stakeholders will need some time to cope and deal with the transition. The government now has a difficult task ahead—they must create conditions that allow borrowers and depositors to remain in a situation that is positive for both quarters. Factors that may adversely affect the reduction of interest rates should be offset by other alternative opportunities. If all these things can be considered, then the government initiative to reduce the interest rate to a single digit will be fruitful for all. Otherwise, a large section of the population, especially those with little financial knowledge and understanding of capital markets and the banking sector, will be made even more vulnerable by these changes.  

 

Zia Uddin Mahmud is a banker and freelance writer. He can be reached at Ziauddin24@gmail.com.

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