Interest rate cap: A cautionary tale
Skip to main content
  • Home
  • Economy
    • Aviation
    • Bazaar
    • Budget
    • Industry
    • NBR
    • RMG
    • Corporates
  • Stocks
  • Analysis
  • World+Biz
  • Sports
  • Features
    • Book Review
    • Brands
    • Earth
    • Explorer
    • Fact Check
    • Family
    • Food
    • Game Reviews
    • Good Practices
    • Habitat
    • Humour
    • In Focus
    • Luxury
    • Mode
    • Panorama
    • Pursuit
    • Wealth
    • Wellbeing
    • Wheels
  • Epaper
  • More
    • Subscribe
    • Videos
    • Thoughts
    • Splash
    • Bangladesh
    • Supplement
    • Infograph
    • Archive
    • COVID-19
    • Games
    • Long Read
    • Interviews
    • Offbeat
    • Podcast
    • Quiz
    • Tech
    • Trial By Trivia
    • Magazine
  • বাংলা
The Business Standard

Wednesday
February 08, 2023

Sign In
Subscribe
  • Home
  • Economy
    • Aviation
    • Bazaar
    • Budget
    • Industry
    • NBR
    • RMG
    • Corporates
  • Stocks
  • Analysis
  • World+Biz
  • Sports
  • Features
    • Book Review
    • Brands
    • Earth
    • Explorer
    • Fact Check
    • Family
    • Food
    • Game Reviews
    • Good Practices
    • Habitat
    • Humour
    • In Focus
    • Luxury
    • Mode
    • Panorama
    • Pursuit
    • Wealth
    • Wellbeing
    • Wheels
  • Epaper
  • More
    • Subscribe
    • Videos
    • Thoughts
    • Splash
    • Bangladesh
    • Supplement
    • Infograph
    • Archive
    • COVID-19
    • Games
    • Long Read
    • Interviews
    • Offbeat
    • Podcast
    • Quiz
    • Tech
    • Trial By Trivia
    • Magazine
  • বাংলা
WEDNESDAY, FEBRUARY 08, 2023
Interest rate cap: A cautionary tale

Analysis

Beidi Gu
18 January, 2020, 01:15 pm
Last modified: 18 January, 2020, 02:23 pm

Related News

  • Maqsuda Begum made new executive director of Bangladesh Bank
  • BB instructs checking dollars spent against each passport before fresh endorsement
  • Bangladesh Bank, Brac Bank organise awareness programme on FX clearing through RTGS
  • NCC Bank holds workshop on CMSME refinance, credit guarantee scheme of Bangladesh Bank
  • Bangladesh Bank signs agreement with SIBL

Interest rate cap: A cautionary tale

What is alarming is that Bangladeshi banks would start with less of a cushion than their peers in Kenya

Beidi Gu
18 January, 2020, 01:15 pm
Last modified: 18 January, 2020, 02:23 pm
Interest rate cap: A cautionary tale

Over the past few months a renewed debate has arisen on the merits of an interest rate cap on bank loans. 

The intention is to encourage economic growth by helping lower the cost of funds and increase access to credit for businesses and individuals. While well-intentioned, the results of the rate cap will likely be the direct opposite. 

Credit, particularly to individuals and small and medium enterprises (SME), will likely dry up, increasing the vulnerability of the banking sector and jeopardizing economic growth and stability. 

Global investors have seen this "movie" play out elsewhere - history shows that a rate cap will have highly negative, if not disastrous, results.

In Africa, the Kenyan parliament passed a bill in September 2016 capping interest rates on loans at 4% above the policy rate. The rate cap was removed in November 2019 because it failed to achieve its goals, and for those three years caused significant harm to the economy and well-being of the people. A memorandum by the president to parliament calling for 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."

As Figure 1 below illustrates, as lending became unprofitable for banks, real credit growth rate turned from double digit to negative almost immediately after the rate cap was implemented. 

In particular, smaller banks that lent to individuals and micro and SMEs were hit hard. As the memorandum pointed out, "Studies indicate that the lending activity … (declined) by about 5 percent in the 12 months ending September 2017. Small banks have been disproportionately hit by capping due to their different business model of relying more on higher-risk/higher-return borrowers...." The memorandum also noted the "mushrooming", or growth of loan sharks and unregulated lenders that took advantage of the lack of financing available to small businesses and individuals. The result - Kenya's private sector credit to GDP ratio shrank from a pre-rate cap high of 34% to 28% by 2018.

The economy suffered, with growth 0.4% lower in 2017 and 0.2% lower in 2016 as credit dried up. Government tax revenue growth decelerated from 12% to 5%.

In addition, non-performing loans (NPLs) in the Kenyan banking system shot up from 6.8% in 2015 to 12.3% in 2017. NPLs surged because borrowers' working capital and capital expenditure needs were interrupted. Instead of promoting growth, as the interest rate cap intended, it instead caused defaults and hardships for businesses and individuals.

Kenya is not an isolated example. The World Bank published a study on rate caps around the world and concluded that "interest rate caps often have substantial unintended side-effects. 

These side-effects include … reduced price transparency, lower credit supply and loan approval rates for small and risky borrowers, lower number of institutions and reduced branch density, as well as adverse impacts on bank profitability."

Capping deposit rates does not ameliorate the issue and will likely cause a liquidity crunch for the system. The proposed 3% interest spread with a 6% deposit rate and 9% loan rate barely covers the credit and operational costs of most banks, let alone SME and retail-focused banks that have an intrinsically higher cost base because they must serve many customers as best as they can. Moreover, by offering a deposit rate that is lower than what the market demands, depositors will look for alternative investment venues, causing a slowdown in deposit growth. The resulting liquidity crunch would exacerbate the funding challenges already faced by banks today.

What is alarming is that Bangladeshi banks would start with less of a cushion than their peers in Kenya. NPLs are already high, and profitability levels are much lower than Kenya pre-rate cap. Return on assets was 3.1% in Kenya pre-rate cap, as compared to 0.3% currently in Bangladesh. 

NPLs were 5.6% in Kenya versus 12% in Bangladesh, currently. System shocks can lead to capital shortfalls, and the ability of Bangladeshi banks to absorb such a shock is quite low. The capitalization of the Bangladeshi banking system is already low at 11.7%, as compared to 19% in Kenya before the rate cap introduction. A similar shock could lead to instability in the banking sector, and thus the economy and well-being of the people.

There are more effective means to promote access to credit. The government is already on the right path by reducing the attraction of the National Savings Certificates, which compete with bank deposits. A reduction of the budget deficit and government borrowing from banks should also alleviate the crowding out effect and allow for more deposits being directed towards commercial loans rather than government securities. Likewise, on the demand side the government is doing a good job of supporting key industrial sectors, such as textiles. Other positive steps include reducing loan scams and large borrower defaults so that liquidity can flow to productive users. Promoting technologies that reduce credit distribution costs will also help in the long run.

Bangladesh has one of the most impressive records of economic growth in the world over the past decade. It is laudable that the business community is not complacent and is thinking of ways to stimulate further progress. Unfortunately, rather than being a device to help the private businesses that have been Bangladesh's growth engine, the rate cap will be a hindrance. It could have calamitous consequences for the country's economic stability, which has been exemplary among developing nations over the past decade.


Beidi Gu is a Managing Director and serves as a Portfolio Manager, overseeing The Rohatyn Group's beyond BRIC public equity investment strategies. She is based in New York. This article is solely Beidi Gu's opinion and does not represent the views or opinions of The Rohatyn Group. 

Economy / Top News / Banking

Interest Rate / Bangladesh Bank

Comments

While most comments will be posted if they are on-topic and not abusive, moderation decisions are subjective. Published comments are readers’ own views and The Business Standard does not endorse any of the readers’ comments.

Top Stories

  • Photo: TBS
    Dhirasram ICD financiers finalised, construction to begin in 2024
  • Photo: Rajib Dhar
    Girls fare better in this year's HSC exams; over 9% drop in pass rate
  • Photo: PID
    Govt making all-out efforts to implement SDGs: PM Hasina

MOST VIEWED

  • People stand in front of collapsed buildings following an earthquake in Kahramanmaras, Turkey, 3 February, 2023. Photo: Reuters
    Why is Turkey an earthquake hot spot?
  • The megaproject Rooppur Nuclear Power Plant has a debt of Tk90,474 crore. Photo: Courtesy
    Projects funded with debt need to be selected prudently, and implemented timely
  • Some tough tasks on the plate for Bangladesh Bank!
    Some tough tasks on the plate for Bangladesh Bank!
  • Having sufficient reserves, strong social security needed to be safe in bad time
    Having sufficient reserves, strong social security needed to be safe in bad time
  • Resilience should be built to cope with long-term implications
    Resilience should be built to cope with long-term implications
  • Why 2012 reforms were not done is a million-dollar question
    Why 2012 reforms were not done is a million-dollar question

Related News

  • Maqsuda Begum made new executive director of Bangladesh Bank
  • BB instructs checking dollars spent against each passport before fresh endorsement
  • Bangladesh Bank, Brac Bank organise awareness programme on FX clearing through RTGS
  • NCC Bank holds workshop on CMSME refinance, credit guarantee scheme of Bangladesh Bank
  • Bangladesh Bank signs agreement with SIBL

Features

Illustration: TBS

Planning to study abroad? Explore these four underrated scholarships

5h | Pursuit
Representational image. Photo: Collected.

The understated perks of journaling

4h | Pursuit
Photo: Reuters

A tragedy that will also shake up the region's geopolitics

19h | Panorama
Nimah designed by Compass Architects- Wooden tiles. Photo: Junaid Hasan Pranto

Trendy flooring designs to upgrade any space

1d | Habitat

More Videos from TBS

30% companies see double-digit growth even in hard times

30% companies see double-digit growth even in hard times

21h | TBS Insight
Challenging time waiting for RMG

Challenging time waiting for RMG

1d | TBS Round Table
"Full Moon Meditation" organized by Department of Theater and Performance Studies, University of Dhaka

"Full Moon Meditation" organized by Department of Theater and Performance Studies, University of Dhaka

1d | TBS Graduates
10 cricketers who have played over 400 T20 matches

10 cricketers who have played over 400 T20 matches

1d | TBS SPORTS

Most Read

1
Photo: Courtesy
Panorama

From 'Made in Bangladesh' to 'Designed in Bangladesh'

2
Master plan for futuristic Chattogram city in the making
Districts

Master plan for futuristic Chattogram city in the making

3
Photo: Collected
Crime

Prime Distribution MD Mamun arrested in fraud case

4
Leepu realised his love for cars from a young age and for the last 40 years, he has transformed, designed and customised hundreds of cars. Photo: Collected
Panorama

'I am not crazy about cars anymore': Nizamuddin Awlia Leepu

5
Photo: Collected
Startups

ShopUp secures $30m debt financing to boost expansion, supply chain

6
ICB to withdraw Padma Bank investment as return eludes
Banking

ICB to withdraw Padma Bank investment as return eludes

EMAIL US
[email protected]
FOLLOW US
WHATSAPP
+880 1847416158
The Business Standard
  • About Us
  • Contact us
  • Sitemap
  • Privacy Policy
  • Comment Policy
Copyright © 2023
The Business Standard All rights reserved
Technical Partner: RSI Lab

Contact Us

The Business Standard

Main Office -4/A, Eskaton Garden, Dhaka- 1000

Phone: +8801847 416158 - 59

Send Opinion articles to - [email protected]

For advertisement- [email protected]