A suggestion has been put forth recently by Prime Minister Sheikh Hasina for the bank owners to reduce lending rate and bring it down to single digit.
Meanwhile, interest rate on loans and advances have started rising again thereby reaching a level it was in two years back. This increase in interest rate has caused concern among the country's business fraternity.
Our previous experience of reducing interest rate is not good at all. The measures were not taken in line with the economic theory and market forces. As a result, attempts to bring down interest rate to single digit during the 2003-04 period did not produce any fruitful result. Instead, the move backfired as severe liquidity crises was created in the market, which eventually skyrocketed interbank (call money) rate to 60-70 per cent. Similarly, measures taken during the last two years for bringing down lending rate to single digit have not sustained. Prior to taking any drastic decision to reduce lending rate, the market forces determining interest rate and the factors impacting this rate should be reviewed in detail, root cause of high interest rate be identified and then remediable measures taken.
DEPOSIT RATE AS FACTOR OF LENDING RATE DETERMINANT: Lending rate in our country is the function of cost of fund, operational expense and return on equity (ROE). Historically, cost of fund in our banking industry is very high. Because, banks have to exclusively rely on depositors' money for their loanable fund. In order to mobilise depositors' money, banks can offer three forms of accounts - current account, savings account that includes STD (Short Term Deposit) and FDR (Fixed Deposit Receipt). Since current account is cost-free, banks can collect tiny portion of fund through this non-interest bearing account. The lion's share of the banks' loanable fund comes in the form of savings account and FDR, which are really very expensive source of fund. Because, most of the people keep their money in banks to earn money. So, they prefer to continue depositing money either with savings account or the FDR as long as comparatively higher interest is paid. Moreover, bankers have to compete with other risk-free interest rate referred as government savings certificate (Sanchayapatra), which always provide a high rate of interest.
Hence, it is obvious that the banks will not be able to unilaterally reduce deposit rate. If they want to do so, they have to face liquidity problem. Because, deposit may move from bank to government savings certificate. At the same time, banks are not allowed to lend to the extent of cent per cent deposit mobilised as they have to maintain mandatory SLR (Statutory Liquidity Ratio) and CRR (Cash Reserve Ratio) with the Bangladesh Bank (BB). Besides, banks' lending ability is further restricted by the ADR (Advance to Deposit Ratio) stipulated by the country's central bank. So, experience shows that a bank on an average can lend maximum 75-80 per cent of its total deposit mobilised and as such cost incurred for mobilising 100 per cent deposit is appropriated to 80 per cent loanable fund, which eventually results in higher cost of fund. In addition, no alternative as well as competitive source of fund has got developed in our country as of now. The hands of our banks, thus, are very tight as they can go nowhere, but to the depositors for mobilising their fund. Technically, our bankers have very little control or almost no control at all over their cost of fund.
BANKS' OPERATION COST: Another component of the banks' lending rate is operational expenses, which is relatively very high in our country. The lion's share of the banks' operational cost occupies salary and bonuses, rent on premises and stationary uses. These areas need to be properly reviewed and addressed accordingly. Most of the banks have not completed centralisation process of their operation and therefore, they have to maintain large branch premises and head office. Similarly, automation has not been done in a proper way. So, there are duplication and repeat work among the officers. As for example, Credit Officer in a bank branch prepares loan proposal, which is again reviewed and rewritten by another Credit Officer to the Head Office for submission to the Credit Committee or Board of Director for their adjudication. Similarly, there are innumerable activities and operations that are still manually processed instead of getting automated and thus higher cost and inordinate delays take place.
In order to reduce the cost substantially, complete automation and centralisation of the banks' operational procedure are inevitably required, otherwise, there will not be considerable room for reducing lending rate. Similarly, salary and bonuses are areas where standardisation has not been done yet. Those working in the banks' direct revenue generation area and non-revenue generating area i.e. back office/ head office are paid at an equal rate. So, bankers should consider introducing base salary plus incentive pay package, which will not only streamline salary structure, but also ensure equitable pay compensation for all employees of the bank. Moreover, in our banking industry, there is no practice of allocating separate budget for each division or department under which respective department/ division is required to operate. As for reference, departmental budgetary system substantially helps reduce and control banks' operational expenses and thus immensely contribute towards keeping lending rate low. Time has come for our bankers to look into these areas.
ROE AND NPL CONTRIBUTING BANK'S HIGHER LENDING RATE: Return on equity (ROE) is also an important factor in determining banks' lending rate. Because, ROE is the result that the investors deserve. Banks in our country are publicly listed companies, so shares of the banks are traded on the country's bourses. Even, the banks' shares occupy great amount of the market cap and as such stock market index, barometer of the country's capital market, is immensely attributed by the performance of the banks what is appropriately reflected through ROE and EPS (Earnings Per Share). Moreover, banks' overall performance is mirrored through ROE and therefore, achieving lower ROE will have a severe adverse impact on the country's share market. It may, however, be mentioned here that current rate of ROE is severely affected by high volume of NPLs (Non-Performing Loans) as the curse of NPLs has duel impact on deriving ROE and EPS too.
Interest accrued on NPLs cannot be taken into income. Instead, required amount of provision is built up from current earning against NPLs that eventually reduce the overall net income of the bank and thus lessen ROE. In order to compensate the income loss on NPLs as well as provisioning amount, the bank has to increase the spread they add to the cost of capital to determine lending rate. Without addressing longstanding NPL issue, the objective of reducing lending rate may not be achieved. Further competitive benchmarking loan pricing has not been developed yet in our country's banking industry. The benchmarking interest rate policy ensures lower rate for borrower with good standing while higher rate for bad borrower.
STREAMLINING BANKING INDUSTRY: For the last few years, our banking industry has been passing through very bad time as many financial scandals and loan frauds, including large loan debacles of Hallmark, Basic Bank, Bismillah Group and some other ones have not only stained the industry, but also disturbed the government as well. The present government had to withstand severe criticism from the opposition political parties and different professionals for banking sector's failure. Even government's achievements in many areas have been marred by the anomalies prevailing in the country's banking industry.
All stakeholders should therefore work together to streamline the country's banking industry.
Nironjan Roy, CPA, CMA, is a Canada-based banker.