The concluding part of his two-part article on Bangladesh financial markert
To reduce the market distortion in financial prices, currently existing in the financial market in Bangladesh, several policy strategies can be adopted to ensure a competitive interest rate structure in the financial market.
IMPLEMENTING A MARKET-DRIVEN INTEREST RATE STRUCTURE: A competitive and market-driven interest rate structure should be adopted in all depository institutions and financial intermediaries in the financial market in Bangladesh. This is vital for ensuring a level playing field for all the financial intermediaries so that they can gain efficiency in financial intermediation. Since the government is implementing a single digit band (6-9 per cent) as deposit-lending rates in banks, it should also consider bringing down the higher interest rates on National Savings Certificates (NSCs) and Postal Deposit Schemes where interest rate ranges from 9.0 to 12.0 per cent. Otherwise, current tendency of fund diversion to public savings will not stop, and therefore, fewer funds would be available for investment by financial intermediaries. However, the government may offer different types of investment opportunities for pensioners and old age (above 65 years) population with incentives, such as tax rebate on interest rates and so on.
If the policy option-1 is considered, there are significant administrative issues. To ensure market-determined interest rate structure in the financial market, both the Ministry of Finance and Bangladesh Bank need to work together in formulating interest policy on all saving instruments, so that no distortions remain in the market. This policy would certainly create a level playing field for all depository institutions and thus market will be more efficient in mobilising savings. Due to this strong positive implication, we have assigned points 5 out of 5 and also weight 0.3 for administrative assessment criteria since administrative initiative will provide the basic foundation of the process which has serious implication on the entire financial market.
In terms of political assessment criteria, we have assigned points 3 out of 5 and weight 0.2 because the policy might have negative effect on politicians who are looking for higher returns to pile up their money but at the same, they might have a positive intention to offer an equitable financial system to the general people as a political commitment.
In terms of economic criteria, the policy would certainly have positive impact on the financial intermediation process which eventually impact savings and investment of the economy. That is why, we have assigned points 5 out of 5 and weight 0.3 for economic assessment criteria. And obviously the policy would have social impact as well. Society as a whole will be benefited from the economic development generated from a distortion-free financial system. However, we have assigned points 3 out of 5 and weight 0.2 considering the financial loss of the pensioners and old age population who do not have alternative investment opportunities other than the high yielding government saving instruments.
REDUCING NON-PERFORMING LOANS: High non-performing loans (NPLs) in banks and FIs held back the inflow of fund for the financial intermediaries in Bangladesh. As of December 30, 2019, total NPLs stood at Tk 9431.3 billion after rescheduling a record Tk 5018.6 billion in 2019 taking the advantage of recent BB's relaxed loan rescheduling policy announced in May 2019. However, such news stories on NPL have downgraded the level of confidence of common people (including depositors) on NPL affected banks. As a result, it becomes hard to mobilise deposit for banks and FIs.
Moreover, higher NPL of a bank will directly affect its profitability as the Return on Assets (ROA) and Return on Equity (ROE) will fall. Since the price-sensitive information impacts the share price in the capital market, public confidence on banks would be affected. Therefore, banks need to take care of their asset quality to be able to continue their cash flow and at the same time gain reputation to attract deposits from savers even at a lower interest rate. If the market determined deposit interest rate is even not much higher, the banks with good quality loan portfolio would be able to generate adequate fund to private sector investment if the repayment behaviour of the loans is regular, and thus contribute in attaining higher economic growth.
If the policy option-2 is considered, there are significant administrative issues. To reduce the burden of non-performing loans, both the Ministry of Finance and Bangladesh Bank need to work together in formulating appropriate loan disbursement as well as loan recovery polices that bring changes in borrowers' loan repayment behaviour and at the same time lenders should be prudent in selecting borrowers. Also, loan administration policy of the lenders should be strong so that proper monitoring of the loans and recovery of the NPLs is ensured. Bangladesh Bank also shall enhance its monitoring capabilities to oversee the loan administration of the banks and FIs especially for NPLs. Considering all these administrative and regulatory issues we have assigned points 5 out of 5 and also weight 0.3 for administrative assessment criteria.
In terms of political assessment criteria, we have assigned points 2 out of 5 and weight 0.2 because the policy might have negative effect on politicians, many of them are businessmen and also loan defaulters, but at the same time, the government has a strong commitment to bring discipline in the financial market reducing NPLs at the shortest possible time.
In terms of economic criteria, the policy would certainly have positive impact on the financial intermediation process which eventually impact especially on investment of the economy. To continue the current higher growth trajectory and meet the targets of SDGs, we need to increase investment to a large extent. Therefore, reducing NPLs would ensure available fund flow for further investment. That is why we have assigned points 5 out of 5 and weight 0.3 for economic assessment criteria. And obviously the policy would have social impact as well. Society will be benefited from the economic development generated from investment activities. As a result, employment and GDP will increase and eventually social welfare will also increase. Therefore, we have assigned points 3 out of 5 and weight 0.2 considering the higher inequality in income/wealth distribution in Bangladesh. Currently, the Gini coefficient is the highest in Bangladesh compared to the rest of the world. The point here is, although we might have more financial resources available due to NPL reduction policy, the benefit generated out of this policy might not be distributed equitably in the society, and therefore, might have little impact on social welfare.
DEVELOPMENT OF SECONDARY BOND MARKET: Development of secondary bond market could be another policy option by which fund can be mobilised for investment and thus attain higher economic growth. Due to the absence of secondary bond market in Bangladesh, fewer bonds are issued in the primary market for financing investment projects. As a result, even after about 50 years of independence, banks and non-bank financial institutions are the main source of investment financing in Bangladesh. Since banks and FIs generally mobilise short-term deposit with maximum tenor of 3 to 5 years, it is not wise to invest such fund for long term financing. But due to lack of a strong capital market as well as secondary bond market, banks are financing for long term investment with short term deposits, which eventually put them in trouble with asset-liability mismatch problem. Such asset-liability mismatch is essentially compelled the banks and FIs for a higher interest rate structure. If a secondary bond market can be developed, more bonds will be issued in the primary market resulting in a competitive price for mobilising fund for banks and FIs.
If the policy option-3 is considered, there are significant administrative issues. To develop a secondary bond market, both the Ministry of Finance, Bangladesh Securities and Exchange Commission (BSEC) and Bangladesh Bank need to work together to formulate appropriate policy. BSEC along with the stock exchanges and investment banks shall enhance capacities for well-functioning of the market. Since our capital market still could not pose a good impression in investor's mind, it may not be easy to overcome such limitations with administrative initiatives. Considering all these issues we have assigned points 4 out of 5 and weight 0.3 for administrative assessment criteria.
In terms of political assessment criteria, we have assigned points 2 out of 5 and weight 0.2 because the policy might have no significant impact on politician at the moment, however, if the proposed secondary bond market is developed, the political commitment for establishing a well-functioning and competitive financial sector would be fulfilled.
PREFERRED POLICY OPTION: Implementing market-determined interest rate structure in the financial market in Bangladesh would be an appropriate policy to eliminate the existing distortions in financial prices of the market created due to differential interest rate structure, such as higher interest rates in NSCs and postal savings schemes compared to currently implemented single digit interest rate band (6-9 per cent) for deposit-lending interest rates in the banking sector. The preferred policy option also supports the views of the proponents of financial liberalisation McKinnon and Shaw (1973), where they termed most developing economies as 'financially repressed'. Financial repression implies distortions of financial prices including interest rate controls. They argue that administratively determined nominal interest rates hold the real interest rate below its market equilibrium level. They further contend that savings will be allocated and invested more efficiently in a liberalised environment.
In addition to the preferred policy option (i.e., policy option-1), we would also recommend that policy option-2: reducing non- NPL can be considered as a supplementary policy to achieve the goal. The high volume of NPLs reduces the capacity of the banks and FIs to generate funds for prospective investment at a reasonably lower cost. Therefore, implementing a market determined interest structure together with NPL reduction strategy will work better for the banking sector to mobilise adequate financial resources to allocate funds for investment in different sectors of the economy and attain higher economic growth.
Dr M. Kabir Hassan is Professor of Finance at the University of New Orleans, New Orleans, USA. [email protected]
