Rate caps to worsen default loan once again : Fitch 

The government's decision to implement single digit interest rate is likely to put the banking industry on the course of continued surge in default loan, projects Fitch, a global rating agency.  

The interest rate capping would weaken the banks by restraining their ability to fix adequate pricing of risks amid poor lending practices and a weak bad loan recovery framework in the country. This would likely lead to further acceleration in the accumulation of default loan at both state owned and private commercial banks.

Fitch came up with the observation in its report titled "Industry Forecast - Interest Rate Caps Pose Severe Downside Risk to Bangladesh's Financial Stability" published on Wednesday. 

The December figure says default loan came down to 9.19 percent from a decade-high 12 percent in September last year. 

Massive loan rescheduling of Tk50 thousand crore under a controversial rescheduling offer helped banks to cut default loan of Tk22 thousand crore in the last three months of 2019.

If the rescheduled amount is considered, the country's default loan would shoot up to 16.49 percent of September's total loan.

"On the whole, we highlight that the government's persistent intervention in the banking sector would raise the risk of another bank run in Bangladesh due to a loss in depositor confidence. The most recent example of this was panic withdrawals in March 2018 following irregularities that were uncovered during Bangladesh Bank's investigation into the Farmer's Bank Limited (now known as Padma Bank) and NRB Commercial Bank (NRBCB)," Fitch said in its report. 

The government is going to implement single digit interest rate at 9 percent from 1st April. Some banks have already brought down deposit rate at 6 percent as part of the plan of implementing single digit lending rate. 

Fitch apprehended that the implementation of the single digit lending rate will be delayed further beyond April due to persistent pushback from private commercial banks. 

Private banks have already put off the interest rate adjustment for more than a year which points toward an inability of the authorities to enforce the regulation and suggests that the implementation of the 9 percent lending interest rate cap is likely to remain slow, the report said. 

"While the actual implementation timeline is uncertain, we believe that authorities would eventually tighten its grip on the industry and push through this initiative so as to continue propelling real GDP growth above 8 percent following an 8.2 percent growth rate in FY2018/19."

"We believe that higher interest rates are likely due to wide credit spreads reflecting the risky lending environment in Bangladesh."

"While there is an alternative scenario whereby banks cut back on loan issuances to reduce their risk exposure, which would slow the growth of default loans, we believe that the government is likely to step in to spearhead higher loan growth to attain its ambitious economic growth targets, which would once again put the industry on course for a continued surge in default loans," according to the report. 

A cap on the interest rates for these loans would inhibit adequate risk pricing and likely give perverse incentives to less creditworthy borrowers as a result. While lower interest rates would support a recovery in loan growth, which slowed to 10.4 percent y-o-y in December 2019, from 14.8 percent y-o-y a year ago. The acceleration in loan issuances is likely to see a renewed build-up of default loans and correspondingly, provisioning, which would weigh on earnings and the profitability of the banking sector as a whole, the report said.

Fitch apprehended that an eventual implementation of interest rate cap will pose severe downside risk to Bangladesh's financial stability, and worsen the risk of a run on deposits.

The capping lending rate will also worsen asset quality in Bangladesh's banking sector. This is likely to see the dismal asset quality situation of state banks' spill over to the relatively healthier private banks. 

The gross default loan ratio of state banks stood at 31.5 percent of total loans in September 2019, only slightly less than 31.6 percent in June. State banks hold more than 50 percent of total default loans.