Why Bangladesh Bank should lift restrictions on consumer credit
In this article I suggest a different approach to Bangladesh Bank’s lending programs to assist the recovery of the economy. The approach suggested here is meant as a complement to BB’s approach.
The key to recovery of the economy is to find ways to increase demand from Bangladeshi consumers. Demand is based on income earnings both current and expected.
There are three things that must be accomplished: Getting income in the hands of consumers; producing goods and services that people want; and inducing confidence that the income flow will continue.
Bangladesh Bank’s approach to supporting the economy is to open credit lines for working capital with subsidized interest rates [ie the bank earns 9% but BB pays half and the borrower pays half]. The idea is simple enough; there are several alternative outcomes:
1. The enterprise may be undecided as to whether demand is sufficient to justify going into production and the opportunity to obtain a loan at a lower interest rate will induce the enterprise to make the decision to produce.
2. The enterprise has decided to produce, but the favourable credit terms lead it to increase its planned output or it will increase its net profits and strengthen its financial position.
3. Many firms will be restarting or expanding production having carried substantial debt, delayed payments to suppliers, or fallen behind schedule in loan repayments, wage payments, rental payments, etc. and will use the proceeds partly to cover such costs and partly to expand production.
In such cases the firm hopes that the working capital lending will continue and it will gradually increase production to repay the loan that it has partially used to cover the backlog of costs.
4. Companies may take the loan with no intention to produce and apply its proceeds to covering costs either incurred or future. Such companies will take the working capital loans convincing their bank that they have the intention to increase production.
Of course, in such cases the company will face future difficulties in repaying the loan but hopes for a way out.
For BB’s working capital programs to work as designed, consumer demand must increase, leading to greater enterprise revenues. Export industries depend on the demands from the foreign buyers; the emergence of that demand level is largely independent of actions that Bangladesh can take.
The service component of demand does not depend strongly on working capital lending. Of course all increases in employment generate income and so demand for goods and services. How rapidly these factors will build up is uncertain.
However, this buildup of income and consumer demand is likely to be slow, as enterprises will be cautious in expanding production, until there are signals from marketing that the demand is returning.
The pace of expansion of domestic demand will also depend on the expansion of export demand as the workers engaged in export production will buy things on the domestic markets. Once income is earned, we expect that consumers will be cautious, building up savings while worrying about the future. All these problems indicate that the build-up of domestic demand needs all the support possible.
In 1945, as the war came to an end, the American army began to discharge 10 million soldiers as rapidly as feasible. Orders for tanks, ships, airplanes, all kinds of military equipment stopped.
Like the impact of Covid-19, suddenly a large number of workers lost their jobs as soldiers and as factory workers. Production largely came to a halt. Economists feared a large and long recession.
The American government made available to returning soldiers a great deal of money for housing loans, with low interest rates and no down payments. This led to a big boost to the economy as so many houses, both single and multifamily, were built. Along with housing demand came refrigerators, cookers, radios, television sets, furniture, household textiles, etc. Much of this was purchased on credit.
In addition, credit was readily available for automobiles. In addition to the higher demand for automobiles, it led to major expansions of tire production, and petrol stations and garages to help maintain the cars.
All of this created large numbers of jobs and expanded the production of a wide range of products. Only a small recession took place and the American economy expanded strongly, maintaining a high level of employment.
Bangladesh Bank does not think much of consumer credit and housing credit. Instead, the central bank has this peculiar concept of what constitutes a “productive” loan. A “productive” loan appears to be one that finances a factory, a hotel, an airline, but not a house, school fees, or an automobile. It is an old fashioned, almost socialist idea that consumer welfare is inferior to production in a factory.
At present, Bangladesh Bank has tight limits on the volume of consumer credit and housing credit. Consumer credit is not a large part of loans and more important the amount of such credit cannot grow faster than total loans.
What I propose is that Bangladesh Bank lift these limits to enable a very large increase, say one hundred times, enabling households to increase their borrowing for durable goods, housing, and vehicles.
For housing, the move should be toward lower interest rates and reduced down payments. What the middle class population needs is small apartments. The developer constructs the building with standards established by the government, and sells the apartment to someone whose income is sufficient to make the mortgage payments.
Providing ownership to the middle class owner is essential; we are not talking here about rental facilities. The terms of the loan must enable the owner to sell it to someone who is acceptable to the bank.
The value of the apartment is determined by the market, so when an apartment is sold from the original buyer to the next owner, the new owner takes over the loan and pays an amount to the seller representing the difference between the market value of the apartment and the principal remaining on the loan.
Demands that will come with housing will be for refrigerators, cookers, ceiling fans, furniture sets, water purifiers, kitchen sets, etc. These can be purchased with loans or credit cards. Once individuals own their residence, they will be very keen to improve the apartment.
An item that is very popular that usually requires financing is the motorcycle or motor scooter. These are now being assembled in Bangladesh, and the banks should be ready to establish financing for the many buyers.
A housing and consumer lending program such as described should have an immediate impact on increasing demand for these items, raising employment at the construction companies and manufacturers making these items.
I believe the impact of such programs would be very quick, and the companies making these products would increase production, making use of BB’s working capital windows. In this program, the consumer loan is directly creating the demand. This increase in demand will lead to companies drawing on working capital loans to enable them to increase production.
Without a consumer credit program to increase demand in the domestic markets, companies will be slow to go into production given the uncertainty they may feel with the level of demand. Opening up consumer credit through the banks will trigger a considerable increase in demand.
To make such a program there are certainly changes that have to be made. Credit scoring for individuals would have to improve. Bangladesh Bank might license one or two companies to build such a service.
Stamp duties on sales should be reduced or eliminated. Procedures for foreclosure on housing are needed that are fair to the property owner but recognize that he must pay his debt. Finally, increased financing of housing and motorcycles opens prospects of securitization of loans making new financial instruments available.
I urge Bangladesh Bank to lift the restrictions on consumer credit and encourage use of this tool to help increase employment and production.
Forrest Cookson is an economist who has served as the first president of AmCham and has been a consultant for the Bangladesh Bureau of Statistics.