SMART-based lending rates: Is it a smart move?
Bangladesh Bank's adoption of the SMART lending rate marks a strategic shift from a lending rate cap. The move, which aims to balance inflation and provide flexibility to commercial banks, brings forth both opportunities and hurdles
A smart economy with inclusive growth is a precondition for implementing the 'Smart Bangladesh' initiative and a proactive banking sector can navigate an economy smartly.
Bangladesh Bank has chosen SMART as the basis for the lending rate of the banking sector, with the aim to make the sector capable enough to sustain Bangladesh's emerging economy. However, all market participants, such as lenders, borrowers, and depositors, might not be ready yet to be smart at SMART-based lending rate.
SMART is an acronym for the Six-Month Moving Average Rate of Treasury Bill, which has been since July 2023 to set the final lending rate of banks. Bangladesh Bank uploads the SMART on its website on the first working day of each month, by calculating the average of the last six months of Treasury bill (T-Bill) discount rates.
Banks are instructed to add a margin with SMART to fix the lending rate, considering the ongoing economic instability. Before that, banks had been guided to use a cap on the lending rate of 9.0% for loan pricing, considering the economic conditions derived from the effect of the Covid-19 pandemic from 2020, to the first half of 2023.
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Changing that rate was a necessary decision, as the Bangladesh economy is going through a startling rise in inflation. However, it seems the whole banking sector of Bangladesh is going through a challenge with the imposition of SMART on lending rates.
Undoubtedly, the banking sector plays a significant role in Bangladesh's economic development, especially by providing investible funds to both the public and private sectors, most of which come from public deposits.
Borrowing funds for depositors became quite tricky at 6%, as the inflation rate was already 9.74% in June 2023 and 9.93% in November 2023. Although it has been targetted that the inflation level will come down to 6% within FY 2023–24, it seems very difficult at this point.
Bangladesh Bank has gradually increased the repo rate to address rising inflation. Thus, banks are being compelled to move away from the single-digit (6 and 9%) concept to settle their cost of funds and overhead, and overcome the damages to banking profitability from the prolonged period of low-interest rates.
SMART varies over time. SMART was 7.1% at the very beginning of July 2023, 7.72 in December 2023.
Along with SMART, a margin of 3% was added to finalise the loan pricing of banks, at the start. After that, Bangladesh Bank decided to move up the margin to 3.5% from October 2023, aligning with its decision to increase the policy rate to 7.25% from 6.5%, to curb skyrocketing inflation.
Although financial participants initially welcomed the move, few arguments have been raised over this period, and the financial market is on the fence now. On the one hand, all borrowers are not ready to accept the high rate; on the other hand, the T-bill rate may go up greatly due to the higher demand for short-term funds.
Furthermore, each month, the variation in lending rate has gone beyond acceptance in some cases; like loan disbursement to the Cottage, Micro, Small, and Medium Industries (CMSME) sector.
My take on this issue is that the challenges in the short run can be handled. SMART will help impede inflation by bringing the money supply down slightly, as it discourages businesses from borrowing money and investing indecisively.
Furthermore, the process of selecting loan prices is more market-driven, as SMART is based on actual market conditions. In line with that, the money market will be practical as commercial banks are getting more flexibility in setting their lending rates and avoiding risky investments.
To maintain a balanced spread between the lending rate and the borrowing rate to generate reasonable profitability for banks, it is expected SMART will play a role in reining in the gap, as it reflects the true cost of funds.
On the other hand, the interest rate cap resulted in lower returns, as low as 6%, for which depositors tended to be demotivated to credit their money to banks. As a result, the banking sector was suffering from a loanable fund crisis, particularly in the severe inflation scenario.
Withdrawal of interest rate cap restrictions and synthesis with SMART for loan pricing will support the sector in overcoming the crisis in the long run, as well as help the economy to boost up.
Overall, the lending rate based on the semiannual weighted average discount rate of T-bills is a pivotal step towards fostering a more robust and sustainable financial system, which is also a sign of market efficiency.
By emphasising transparency and responsiveness in the financial system, it is expected lending costs will be reduced, the availability of credit will be ensured, risks managed, and will have a positive impact on the Bangladeshi economy as a whole.
Blithe Rani Aich is a research associate at the Bangladesh Institute of Governance and Management (BIGM).
Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard.
