Puzzling facts about bank loans

The shares of short- and long-term credit have not changed in the last one and a half decades despite a significant structural shift in the economy as well as in the banking sector.
Over the last 20 years or so, Bangladesh has experienced sustained economic growth of about over 5.5 percent per year on an average. We all know what the driving forces of this growth are. However, we have very little knowledge about how this growth has been fuelled. That is, how has this sustained growth been financed? What are the relative roles of financial intermediaries, debt-financing and equity financing?
In fact, it is argued that the engines of growth have been fuelled by the banking sector alone, in the absence of a well-developed capital market and other sources of corporate finance. One of the driving forces of the growth of the real economy—the RMG sector—is largely bank-dependent.
The economic growth critically hinges on the use (industry, trade, agriculture) and term structure (short term versus long term) of credit. There is a huge body of literature that shows the association between higher maturity of bank credit to the private sector and economic growth.
Generally, economic growth is argued to increase with the savings invested in long-term assets. Credit products with longer maturity are essential for financing larger projects with higher returns.
Usually, short-term credit is considered as a bank loan having maturity of less than a year.
On the other hand, term lending or long-term credit is defined as a loan, which is repayable over a year.
While long-term loan is used for financing fixed capital for large projects, short-term credit is used to finance working capital for a shorter period.
Short-term finance is crucial for the sectors, which have short production cycle such as agriculture and trade.
In the developing countries, which are predominantly agriculture-based, short-term credit overwhelmingly dominates the longer term ones.
The composition of short- and long-term loan credit generally reflects the structure of the economy. As the economy shifts from agriculture to service and manufacturing, the composition of term structure shifts from shorter to longer term loan.
As the economy becomes more industrialised, the demand for longer term credit increases.
Therefore, one can envisage that as the economy of Bangladesh has gone through substantial structural shift from agriculture to manufacturing and service, the share of long-term credit must have increased over time.
It is worth noting that the share of manufacturing in national income has increased from about 22 percent to about 29 percent in the last two decades. This shift implies that not only new industrial units have been set up, they have also become bigger and more capital intensive.
This shift requires a proportional response from the financial side and it should be reflected in higher share of credit that is going to finance longer term large projects.
But in reality, this is not the case. The shares of long- and short-term credit have not changed over the last one and a half decades.
In fact, the share of long-term loan in total loan has decreased slightly over the last one decade. In 2001, this share was about 20.44 percent and at the end of 2013, the share dropped to about 18.72 percent.
The shares of short- and long-term credit have been surprisingly very stable over the last 13 years at around 80 percent and 20 percent respectively.
It is also interesting to note that the banking industry also has gone through significant change in terms of relative dominance of private versus public banks.
The market share of public banks has shrunk substantially over the period of 2000-2013. In 2000, about two-thirds of the total credit was disbursed by the public banks while the rest by the private banks.

The situation has reversed over time; now the private banks control two-thirds of the credit and deposit market.
Therefore, structural shift of the economy is closely associated with the changes in relative share of public and private credit but not with the changes in the relative shares of long- and short-term credit.
The reason behind the association between structural shift of the economy and the dominance of private sector credit is obvious. This private sector-led growth has created huge demand for credit, and private sector banks responded proportionately to this demand.
The third generation banks, which entered the market in the late 1990s, also have contributed extensively to meeting the burgeoning demand.
With the introduction of the third generation banks, second and first generation private banks also aggressively expanded their coverage and products.
While private sector banks came forward aggressively to meet the demand, public sector banks remained lazy and inefficient in capturing the growing market and gave rise to this shift in the banking sector in the mid 2000s.
On the other hand, the structural shift of the economy with the constant ratio of long- to short-term credit is apparently very puzzling.
One could argue that it is solely due to the supply side problems. The lower share of long-term deposits determines the under supply of long-term credit. This is in fact far from the truth.
The composition of deposit has also changed substantially over time. At the end of 2000, the share of fixed deposit was about 32 percent and it increased to about 50 percent in 2013.
Deposit with maturity of above 12 months is now about half of the fixed deposit. There are also other types of long-term deposits, such as pension deposits.
Arithmetically, the constant long-term to short credit ratio is due to the fact that both types of credit have increased at about the same rate over the years.
Sectoral composition of credit and how it has evolved over time provide us with some explanation of this puzzle. The largest share of banking sector credit, which is about 39 percent, went to finance trade in 2013.
Industry sector stood second, which is about 21 percent. About 13 percent and 8 percent went to finance working capital and construction respectively.
The shares of credit to finance trade and working capital have increased over time while the share of agriculture has decreased. Industrial credit has remained more or less stable over the last one decade.
The credit that goes to the industry and construction sectors is largely the long-term credit while all other credits, including trade and working capital, are the short-term ones.
This composition sheds light on the fact that it is the growth of trade and working capital financing that contributed to the sustained increase in short-term credit, which matches well with the growth of the long-term credit.
It indicates the extensive commercialisation of the economy as well as the burgeoning growth of the small and medium enterprises, which involve technology with production cycles between 3 to 12 months.
Further, a huge amount of directed credit has been pumped to SMEs by the government and Bangladesh Bank.
While the constant ratio of long-term to short-term credit underscores the growth of trade and small and medium scale industries, it posits that the economy may have trapped into lower growth trajectory, for the given structure of finance.
Since the growth of Bangladesh is largely self-financed, we may not achieve double-digit growth with the current supply of long-term large credit.
It seems the current banking sector, with its limited range of products, may be good at financing 6 percent to 7 percent growth, but not more. But if we want to lift the country to the middle income level in less than seven years, this growth rate is not sufficient.
We need innovative tools to finance higher sustained growth, be it debt or equity financing, domestic or foreign.

The writer is a research fellow at Bangla-desh Institute of Development Studies.