Two things are happening with the banks today – first, they are reining in credit to the private sector which they think is risky, and secondly, they find the government's appetite for money more profitable.
Giving credit to the government is profitable as the long-term treasury bills are fetching between 8-9 percent interests depending on maturity periods against 3-6 percent about two years back. So the banks find it a better source for investment.
The government's capping of lending rate at 9 percent from April 1 has also made the banks conservative because they have to keep their non-performing loans to a bare minimum if they have to lend at a single-digit.
The adoption of this new business strategy by banks to avert risky lending is causing excess liquidity to pile up and private sector credit growth to drop substantially.
Liquidity increased by 65 percent to Tk1 lakh crore in November last year from Tk60,000 crore in May, according to Bangladesh Bank data.
Most of this excess liquidity lies with the private banks.
Of the excess amount, a major portion remains invested in government treasury bills while just around Tk6,000 crore sits idle as cash.
When banks increasingly invest in government treasury bills, liquidity rises.
Moreover, banks have adequate holdings of foreign currency amid increasing remittance growth and a fall in opening letters of credit.
Currently, banks' total foreign currency holdings are around $1 billion – which is considered sufficient for banks' daily transactions. An adequate inflow of foreign currency has also increased the supply of liquidity in the banking system.
However, despite this comfortable liquidity position, the private sector still has a shortage of funds as credit growth fell to 9.9 percent in November last year and was likely to drop further in December.
Therefore, Bangladesh Bank has recently loosened its monetary policy by increasing broad money growth by 0.5 percentage points – to 13 percent – for the second half of the current fiscal year.
Broad money is a category for measuring the amount of money circulating in an economy. Central banks usually control broad money growth to manage inflation.
A senior executive of Bangladesh Bank, who is involved with monetary policy, said broad money growth is increased to raise the supply of money and boost credit demand.
He said in the last two years, the money supply was tight as net foreign assets were negative. As a result, banks bought foreign currency from Bangladesh Bank in exchange for money, causing a liquidity crunch in the banking system.
The situation has changed as net foreign assets have turned positive amid strong remittances and a balance in export-import growth.
Thus, the central bank has increased the space for broad money growth to boost the supply of money on the market and the target may be further increased if the liquidity position improves, he said.
He said Bangladesh Bank is also pursuing private banks to focus on private sector lending. Though private sector credit growth remains far below target, the central bank – in its revised monetary programme – has kept the credit growth ceiling unchanged.
Though managing inflation is a major responsibility for Bangladesh Bank, it is very worried about inflationary risks. Current rising inflation is not because of a monetary effect, but instead, it is due to some major mismatches in the supply of goods caused by the onion crisis and floods.
"We are trying to increase broad money growth in two ways – one is through government borrowing and the other is through private sector credit growth."
Bangladesh Bank does not want to restrict government borrowing because banks are reluctant to lend to the private sector amid the single-digit interest rate move, he said.
The new ceiling for the public sector credit growth has been set at 37.7 percent for the fiscal year ending in June – up from the previous target of 24.3 percent.
"Aggressive government borrowing from the banking system will cause a crowding-out effect in the private sector," said Dr Zahid Hussain, former lead economist at the World Bank's Dhaka office.
He said banks receive above nine percent interest on their investments in long-term government instruments.
"Meanwhile, the government is going to cap the lending rate at 9 percent. So why would banks lend to the risky private sector instead of invest in risk-free government instruments?" he asked.