• Sunday, Jul 05, 2020
  • Last Update : 05:19 pm

OP-ED: Listening to the market

  • Published at 01:04 pm June 26th, 2020
calculator interest rates
Some calculations are in order / BIGSTOCK

Looking at the interest rate cap from a policy and regulation perspective

The private sector credit in Bangladesh has reached to a historic low of 8.2% in March this year and it is feared that it would slide further in the coming days.

In order to understand it, let’s begin with some calculations. 

The weighted average cost of deposit of banking industry is 5.37% and private banks are at 5.81% (source: BB, April 20 Interest Rate Spread), credit cost of banking sector is 2% or 200 bps, for better-performing private banks it is 60 to 100 bps. The average operating costs in the banking sector is 3% (BB: 2018) and the latest liquidity cost (cost of cash reserve ratio-CRR cost is 20 bps. 

Now, if we add all these cost components together, the minimum cost of doing business is at least 11% at the industry level.

Now the questions arise: What would you do when your product cost is 11% and you are allowed to charge at 9%? How is your business going to be profitable? 

It’s possible to for anyone to argue that we can reduce the operating costs. Let’s agree to that. Well, if we reduce the operating costs to 2%, the cost of product is still 10%, which is higher than 9%! Now, how you can reduce your operating costs? The major components of operating cost is its people (50%+) and the rest are distribution channel, technology platform, and other administrative expenses. 

Let’s come further at the granular level. 

The operating cost of SME (small and medium enterprise), primarily the cottage, micro, and small business, is much higher than corporate segment or large ticket size lending due to lower ticket size, its people involvement, the lack of proper books of accounts and record-keeping of those business, doing business at dispersed and remote locations, and the customers having minimum or zero collateral. 

In addition, the banks are not allowed to change any fee for the SMEs except for a few heads which are negligible. The question is: If the banks are not allowed to cover its high operational and collection costs in terms of risk premium/maintenance, why would they do this business or lend to this specific customers?

The answer would certainly be required.

Having said that, let’s look at how loans are performing. The non-performing loan (NPLs) percentage is skyrocketing and the percentage of restructuring and rescheduling is snowballing although Bangladesh Bank has relaxed the loan classification since mid-2019. 

Businesses, whether it is a bank or any other business, should be allowed to become profitable to allow it to grow and to provide their products and services. We have more than 10 new banks whose current Cost of Deposit (CoD) is more than 7% (Source: BB April 20 Interest Rate Spread). 

It’s next to impossible to imagine where they would get sufficient deposits to lend to their customer at 9% and how they would make their business sustainable.

There are more. 

It is imperative that the high-risk segments ie the new entrepreneurs or the start-up businesses have borrowing opportunity from the banking sector at a certain risk premium. But with the current 9% rate, the banks may not be very interested to lend those green-field sectors.

If we follow a “one size fits all” strategy for each customer segments and across the loan tenures, it may not be not be workable at all, as it has not worked in other countries. The recent example is Kenya, which had reverted back from the rate cap regime after a few years of experiment.

The Kenyan parliament passed a bill in September 2016 capping interest rates on loans to 4.0% above the policy rate. The rate cap was removed in November 2019 because it failed to achieve its goals, and those three years caused significant harm to the economy and well-being of the people. 

A memorandum by the president to parliament calling to repeal stated: “It is apparent that the capping of interest rates has caused unintended effects that are significant and damaging to our economy and in particular, the Micro, Small and Medium Enterprises (MSMEs) which are the hardest hit.” 

A 9% rate cap will impact on the capital requirements of the banks and discourage higher risk segment customers to get financing from banks. According to BASEL-III guidelines, banks have to keep 12.5% minimum capital requirements on its Risk Weighted Assets (RWA). RWA is the concept of multiplication of the loan outstanding with risk weight/credit rating of that customer. 

Now, the question is: If bank capital varies by their risk weighed assets and if the returns are same ie, 9%, why would banks lend to 100% + risk weighted customer group ie credit rating of the customer is 100% or above, as it would impact on its capital requirement, and what will happen if those customer groups would not have the lending access from banking channels? 

It indicates private customer credit growth would fall from unrated or risk client segment groups, which ultimately impact on the overall private credit growth of the country.

We may need to rethink it from the policy level and regulation perspective. We need to run a survey on what good the rate cap has brought for the customers mainly from SME and retail customer groups. We have to listen to what the market says. Are we willing to?  

Md Yasir Arafin is a banker and a Fellow Member of ICMAB. He can be reached at [email protected].

483
481
blogger sharing button blogger
buffer sharing button buffer
diaspora sharing button diaspora
digg sharing button digg
douban sharing button douban
email sharing button email
evernote sharing button evernote
flipboard sharing button flipboard
pocket sharing button getpocket
github sharing button github
gmail sharing button gmail
googlebookmarks sharing button googlebookmarks
hackernews sharing button hackernews
instapaper sharing button instapaper
line sharing button line
linkedin sharing button linkedin
livejournal sharing button livejournal
mailru sharing button mailru
medium sharing button medium
meneame sharing button meneame
messenger sharing button messenger
odnoklassniki sharing button odnoklassniki
pinterest sharing button pinterest
print sharing button print
qzone sharing button qzone
reddit sharing button reddit
refind sharing button refind
renren sharing button renren
skype sharing button skype
snapchat sharing button snapchat
surfingbird sharing button surfingbird
telegram sharing button telegram
tumblr sharing button tumblr
twitter sharing button twitter
vk sharing button vk
wechat sharing button wechat
weibo sharing button weibo
whatsapp sharing button whatsapp
wordpress sharing button wordpress
xing sharing button xing
yahoomail sharing button yahoomail