Implementing single digit interest rate in the short run will discourage people from saving, create temporary deposit crisis in banks and squeeze lending, said a Bangladesh Bank analysis.
The central bank did an in-depth impact analysis of implementing single digit interest rate considering seven factors – impact on savings, inflow of remittance, deposit collection of banks and non-banking financial institutions, inter-bank deposit, SME and consumer loan, private sector credit, and foreign trade.
A committee that the bank formed on the issue of single digit interest rate submitted the analysis report to the governor, Fazle Kabir, on January 9.
The government is going to implement the single digit interest rate from April 1.
The report said deposit rate will decline if lending rate is set at nine percent, and this will discourage depositors from keeping their deposits in banks.
As of December last year, 20 banks have deposits of less than a six-month tenure at six percent interest rate or less, and 38 banks have deposits at 6.5 percent to 10.25 percent, according to the report.
However, foreign banks' interest rate on deposit is comparatively much low, which means deposit collection is possible even in low rate.
The report also mentioned the positive side of single digit interest rate, saying the nine percent lending rate will reduce the size of loan instalments and that will improve loan payment capacity.
The committee recommended a two percent penal interest on default loan, which will encourage borrowers to pay instalments regularly. As a result, default loan will decline which will reduce provisioning requirement, thus helping banks make more profit.
The increase in profit will improve banks' health which will ultimately lure depositors back, the report said.
It said depositors will switch to non-banking financial institutions, non-governmental organisations and co-operatives to get high interest rate. However, overflow of deposits will force these organisations to cut interest rate as they do not have the capacity to invest.
Moreover, depositors will come back to banks to ensure the security of their money, the report hoped.
Data from the Bangladesh Bank show that deposit growth saw a sharp fall in October last year to 8.86 percent year-on-year, which was in double digits several months back.
The report said single digit interest rate will hurt credit inflow to the private sector as banks will be reluctant to lend at low cost.
However, low lending rate will help businessmen cut their operational costs.
Private sector credit growth already touched bottom, hitting single digit in November, and the trend is likely to continue in the coming months, said industry insiders.
The Bangladesh Bank report said single digit interest rate will reduce LC (Letter of Credit) opening, hurting imports and exports.
Import growth fell by 5.26 percent in the first five months of the current fiscal year while export declined by 7.51 percent, according to the central bank data.
The single digit interest rate will not hamper remittance inflow as the two percent cash incentive keeps the flow strong, the report said.
It said inter-bank deposit will not be affected much if government mandates autonomous and semi-autonomous bodies to keep deposit in private banks at a certain rate.
Meanwhile, the Ministry of Finance has declared that government organisations will get six percent interest on their deposits in private banks, and 5.5 percent in state-owned banks.
A circular issued on January 20 in this regard also said the autonomous and semi-autonomous bodies can deposit 50 percent of their funds allocated under the Annual Development Programme in private banks and non-banking financial institutions.
On December 1 last year, the Bangladesh Bank formed a committee to find a way to cut interest rate to single digit, as private banks could not lower their lending rates even a year after promising to do so.
The committee, headed by a deputy governor of the central bank, placed the report to the board on December 24, recommending single digit interest rate only for the manufacturing sector.
The board later asked the committee to submit a revised report after doing an in-depth analysis of the impacts of implementing single digit interest rate.