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1 Ans Single Digit Interest Rate in the Banking Sector: Problems and Prospects - essay writing

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Single Digit Interest Rate in the Banking Sector: Problems and Prospects

A new controversy has emerged in the financial sector, especially in the banking sector as the Prime Minister asked the banking authorities to bring down interest rate to a single digit for boosting country's investment. This rate is to be at least 6 per cent for the depositors and nine per cent for the borrowed fund leaving the difference between lending and deposit interest rates, known as the Interest or Profit Rate Spread (IRS or PRS) for only 3 per cent. Much have been written and talked so far in the print and electronic media regarding this issue and it would continue certainly for some more periods.

Mentionable here that Bangladesh's financial system is dominated by banks where the banking sector accounts for around 90 per cent of total assets of the financial sector. At present, there are 65 states owned, specialized and private commercial banks including 8 Islamic Shariah-based private commercial banks which are considered a huge number for such a small economy and consequently some sort of unhealthy competition and aggressive banking practices are growing in the banking industry. There are also 36 non-bank financial institutions operating in the country.

This is a reality that high interest or profit rate and a high IRS raises the cost of credit restricting the access of potential borrowers to credit markets thus reducing investments and limiting growth potential of the economy. Moreover, problems become more acute for small businesses, household enterprises and rural industries which are vital to promoting equitable growth and reducing poverty in low-income countries. It is often argued that the higher the IRS, the higher would be the cost of credit to the borrowers for any given deposit rate. Alternatively, a high IRS could mean unusually low deposit rates discouraging savings and limiting resources available to finance bank credit. Whatever the reality is - the rate of interest should not be fixed by any abrupt decision of the government. But it should be based on well researched policy of the regulatory authority and responsive to the market condition. However, hopefully the government has decided to allow state agencies to deposit 50 per cent of their funds with private banks, up from the existing ceiling of 25 per cent, to tackle liquidity crisis. But those funds will not be so easy for the banks to mobilize.


If we investigate the reasons behind lower rate of interest in developed countries and higher rate in the developing countries, we will have a clear idea about the determinants behind the rate. We know that interest or profit rate is the compensation paid for depreciation in the value of currency with time. Thus, higher the inflation rate, higher would be the interest rate. Since inflation is lower in the developed economies, a lower interest rate follows. Moreover, GDP growth rate is also very low for high income economies in general and their currency has strong exchange rate in the global market. Since growth rate is low, they try to boost via low interest rates. Since high income economies have stable governments and economic policies, inflation is often low ranging from 1-2 per cent. So, the real interest rate and nominal interest rate have little difference.


Researchers have attributed the existence of high rate of interest and IRS in developing countries to several factors, such as cost of non-performing loans (NPLs), high state control of lending, absence of risk management practices, limited technical skills, administrative and incidental costs including expenses that the banks incur in setting up new branches and attracting and retaining skilled personnel, advertising, and other expenditures that the banks undertake to increase market share and business, high operating costs, financial repression, lack of competition and market power of a few large dominant banks enabling them to manipulate industry variables including lending and deposit rates, high inflation rates due to huge demand of products and services against limited supply, GDP growth rate, FDI, exchange rate, high risk premiums in formal credit markets due to widely prevailing perception relating to high risk for most borrowers, and similar other factors.


The analysis also shows that the higher the non-interest income as a ratio of total assets of a bank, the lower its spread. Similarly, market share of deposits of a bank, statutory reserve requirements, and NSD certificate interest rates affect the IRS. The analysis in terms of bank groups shows that IRS is significantly influenced by operating costs and classified loans for state owned commercial banks (SCBs) and specialized banks (SBS), while inflation, operating costs, market share of

deposits, statutory reserve requirements, and taxes are important for the private commercial banks (PCBs). On the other hand, non-interest income, inflation, market share, and taxes matter for the foreign commercial banks (FCBs).


This is very much unfortunate that there has been unhealthy competition in the financial market in terms of the rate of interest or profit to the depositors. National Savings Bureau and other agencies are offering higher deposit rate in various savings and term deposit schemes. Therefore, as the depositors are becoming looser by keeping their money in the banks, they are diverting to those government saving schemes. Moreover, there are many cooperative societies and personal borrowers and savers who are not institutional and paying much higher rates to the depositors. Similarly, people also find it more lucrative to keep their money into securities or if there is inflation, they will keep it with themselves as that will prevent them from frequent visits to banks. But this scenario is not good for the sound and steady economic growth. Consequently, banks will not be able to mobilize more funds to lend the investment clients which will be a big obstacle to the industrialization and sustainable growth of the economy.


Some observers suspect that this single digit rate of interest is mostly politically motivated to facilitate the business magnets who have strong influence over most of the key government policies and the main supplier to the political lifeline of the country. Whatever is the reality the rate of interest or profit should be responsive to the demand and supply prevailing in the market as well as should be based on the actual cost of fund of the bank. Otherwise, market discipline will collapse; it would also not bring any good result to the economy.

Answered by Birds of the sky (1 Gold) one week ago

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