Daily Star reports:
The Bangladesh Bank (BB) yesterday asked all commercial banks to submit proposals within two weeks on how to reduce interest spread between lending and deposit rates and charges for different services.
The central bank observed that the state-owned commercial banks charge reasonably for different services, but the rates charged by local private commercial banks are high while those by foreign commercial banks, too high.
…
“We are not imposing anything on the banks respecting the climate of free market economy,” he said adding, “But at the same time we are alert so that none can take any irrational opportunity.”
Can someone explain what this “irrational opportunity” is?
I think BAB’s response has been pretty much on-point
BAB Chairman Nazrul Islam Majumder, however, defended the current rates saying that running private commercial banks requires higher expenses as they need skilled staff on high pay.
“It will be difficult for us to reduce the lending rates unless the interest on savings certificates and treasury bonds are slashed,” Majumder said, talking to the reporters.
“The governor has assured us that the central bank will set the interest rate spread after discussion with all stakeholders,” he said.
There’s a better way. It’s called letting competition do it’s magic.
There are arguments to be made for intervention in many cases. This isn’t one of those cases.
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February 28, 2008 at 3:02 am
Talam
I think the fundamental question here is - are the high spreads charged by banks justified? If so why? If not, what’s keeping the spread high? Depending on the answers to these questions, the BB policy may very well be the appropriate one (moral suasion to counter market imperfection?).
(1) Is the spread justified? How can we even answer the question of whether it is “justified”? Here is one way to think about it:
Equity investors in a company demand a certain ROE commensurate with the risk of their investment.
I took a quick look at Net Income/Net Interest Income ratio for eight different leading banks (my data is a bit old - ~2006) - the average is 13.71% (max=20.23%, min=7.18%). I am not a financial analyst (and am i looking at the right ratio for banks?) but those numbers don’t seem too high to me for the risk of operating in an emerging market country. So, the high lending rate could simply be, to paraphrase BAB, the need for banks to maintain the profit margin required by their investors (also can argue - risk premium is higher in BD => profit margin has to be higher than other countries).
So, maybe the spread is justified as risk premium. To really answer the question, we would need to compare across industries, across similar industry in different countries, etc. etc. So - the above does not answer the question completely.
(2) Another angle - if we can point at blatant market anomalies/inefficiencies that are causing the spread to be too high then we don’t need to worry about point 1 above.
(a) So - why isn’t competition forcing banks to improve operational efficiency and bring down overall costs (and increase ROE in the process)? Maybe it’s already happening and it’s only a matter of time? But according to BB’s monetary policy statement (http://www.bangladesh-bank.org/, MPS, Jan-Jun 08), the spread has been in the ca. 6% range for at least two years now. I can’t believe that the BD banking system is already efficient enough that no more costs can be wrung out of the system. So - why?
(b) Is it an excess of credit demand and high barriers of entry? Anyone have a sense for how difficult/easey it is to get credit from banks in Bangladesh? If it is high barriers of entry, then the policy response can be different (lowering barriers of entry).
(c) BAB says “It will be difficult for us to reduce the lending rates unless the interest on savings certificates and treasury bonds are slashed”
Huh? Don’t understand …. Is this something structural that is stopping banks from lowering lending rates?
[wow - turned out much longer than i thought...
procrastination is the mother of productivity .... ]
February 28, 2008 at 6:22 pm
Talam
[if above can be called being "productive"
]
March 16, 2008 at 9:58 pm
Talam
Update on this topic -
http://www.newagebd.com/2008/mar/11/busi.html