Anyone with a basic understanding of how finance and economics work would acknowledge the fact that the relationship between risk and reward is a positive one. As risk increases, so does risk premium. Even a casual observer would notice that this very fundamental axiom does not hold true in practice for many of the cases in Bangladesh. Some of the exceptions would seem outrageous to the finance purists and practitioners alike.
One such exception could be interest rate capping on loans. The government has fixed a ceiling of interest rate of per cen for all loans (except credit cards). That means irrespective of the cost of fund, riskiness of borrowers, nature of the nature of the industry, prevailing money market conditions, inflation rate, money supply, government borrowing, deposit growth, credit growth and any other changes in macroeconomic factors, banks must find a way to lend at a maximum rate of 9 per cent.
What could be the logical response of such interest rate capping regime? Given the maximum available return on investment (9 per cent), banks are likely to opt for an investment opportunity that has the least amount of perceived risk. Therefore, most banks would vie for the same group of borrowers which are most likely to be in better financial footing and has proven track record in repayment of loans. However, banks would have no incentive whatsoever to choose an investment opportunity that has above average risk profile -- be it because of the nature of business, stages of business life cycle, leveraged position, business size, seasonality, type of financing, tenor and structuring of the loan or fundamental change in business landscape.
An illustration could be a choice of financing between a small business firm with one year operation and a well-established business conglomerate with backing of strong entrepreneurs, both offering same rate of return on investment due to interest rate ceiling. You don't have to be a rocket scientist to find out what would be the preferred option for overwhelming majority of lenders, if not all.
Isn't it almost unfair for the small business firm to be put against this fierce competition? Did the situation actually ask for it? Probably, all it needs is access to funding on timely basis. If the financier with its limited available funds gets entangled in optimisation of risk-return perspective, whose fault will it be when a promising start-up gets nipped in the bud due to lack of proper funding at the right time? I don't think you can find fault with the financier to protect the interest of its depositors and shareholders by being objective and rational about choosing the investment that maximises the value and provides the highest risk adjusted return. More importantly, we need to ask ourselves this question : Is the cost of debt the most important barrier for financial inclusion? Or, is access to credit on timely basis the most important factor? An honest and realistic answer to this question could solve a lot of problems.
Let us look into the reasons why banks charge higher for a SME loan as against a Corporate loan. It's not just profit, as many tend to believe albeit rather naively, that drives the pricing, and there are some solid economic justifications for it. Take the example of direct cost for both financing. A team consisting of 10 people in a dynamic and structured banking environment can look after a corporate loan portfolio of around BDT 10.00 billion, while you will need roughly a team of 200 people to build and monitor a small business loan portfolio for the same amount.
If small loan is viewed as a product for the banks, it will definitely be a costly one. Shouldn't it reflect in the final pricing (interest rate on lending) to the customers? Is the same mark-up justified for the wholesale business and retail business? Is it feasible to compare the margin of someone selling 1,000 sacks of rice per day in Karwanbazar wholesale market and someone selling 20 kg per day in a local departmental shop? Is it fair on either party to fix a single uniform margin for both of them? Some of you might already be shaking your head in the absurdity of the comparison. But, practically that's what is happening when you fix a single uniform interest rate ceiling for all customer segments that differ so much from one another in terms of size, business model, risk and in so many other respects.
Theoretically speaking, if lending to SME at higher rate of interest (before the interest cap regime) was so lucrative, there should have been stiff competition among all banks targeting this segment. Did we actually experience that? In reality, it is quite the opposite. Many banks in the country fail to meet their SME loan disbursement target. Some of them adopt a short cut by financing the MFIs and not going directly to the beneficiaries. There have been instances of banks trying to go big in SME without the required set up and expertise and ending up with a large NPL. Therefore, the banks and FIs that have worked over the years to build up a good ecosystem for supporting SME loan should not be discouraged with arbitrary policies that threaten to make the business model unviable.
Financial inclusion has been a buzzword for quite some time now. Everyone talks about the contribution of SME sector, especially with respect to employment generation. How access to SME financing generates a bigger impact on reduction of inequality and promoting innovations is well documented. At times our policies, however well-intended, become a hindrance to financial inclusion. It's about time we walked the talk on promoting financial inclusion and SME lending.
Not taking into account the inherent high expenses associated with SME lending will lower credit growth in this sector in a big way. Doing away with the fundamental of risk based pricing can affect sustainability of banking business model. Hence, it might be a good idea to stop playing with the "risk premium" and "fundamental of lending" before it's too late. No harm in backtracking on a policy that is clearly not working and will continue to peg back both SME lenders and more importantly affected borrowers. We cannot afford to undo a lot of progress made in the SME sector. Let's hope good sense prevails. And to go with it, a bit of courage will do just fine. Courage to do the right thing, looking beyond the superficiality of populism and focusing on the practicality of sustainable lending solutions might be the order of the day.
Md. Sadekur Rahman is banker. [email protected]
