Banking on banks
Last time an AL-led government was in power it went on a spree granting licenses for the establishment of new banks. Within four years (1997-2000) it added 19 domestic private banks and four foreign banks to the 28 banks that already existed at the time. Perhaps to prevent such indiscriminate increase in the number of banks the relevant law was amended to give Bangladesh Bank the exclusive authority to grant licenses for new banks. It was hoped that that such statutory autonomy would enable BB to act independently in the best interest of the financial sector and the economy. This has proved to be a rather wishful thought. A government can, if it is sufficiently brutish, force any domestic institution to buckle.
No new banks were established since the last BNP-led government took reign in 2001.Â Indeed the number of banks declined as several foreign banks withdrew from the country. But there were fresh efforts to establish more banks after the current AL-led government took over the government in 2009. Bangladesh Bank was alarmed, and initially its Board took a stand against the establishment of new banks. Some of its directors had publicly argued against new banks on the ground that the current tight economic situation did not warrant more banks. However, the finance minister curtly reminded BB that the establishment of new banks was a â€˜political decisionâ€™. Â BB had to eventually submit to the superior will; it granted permission for nine new banks.
BB brought out a short note giving reasons why it regarded granting of licences for new banks economically justifiable. Â It is not known whether the note was BBâ€™s own idea or an imposition; but it did negate its earlier righteous stand, or what the public perceived to be its righteous stand. Its reputation was tarnished.
There have been many stray comments from various government zealots and interested quarters about the justification of new banks, but the note of BB is certainly the most comprehensive statement of the economic logic of establishing new banks. Unfortunately, on closer examination the logic seems untenable.
In order to refute the oft-repeated criticism that in the current difficult state of the economy more banks were not needed, BB gave a short account of the performance of the economy over the last decade: nominal GDP had more than trebled, exports and imports had increased more than three and half times, and remittances and international reserves had increased many fold. Presumably such large increases in these variables provide a justification for establishing more banks.
Actually all these variables represent only the demand side for the banking sector; when GDP and international transactions increase the demand for banking services also increases. There is not much mention in the write-up of the supply side, which is represented by the banking system itself. It is in the nature of a market economy that in order to compete and survive individual enterprises, including banks, must grow. Â Increases in GDP, trade etc. afford them the opportunity to grow. During the period nominal GDP had grown three times, deposits and advances (measures of banking services) had increased by about five and half times. The existing banks have adequately met the demand for the rising banking services. In addition many new products such as ATM, mobile banking etc. were also introduced.Â Indeed, all these were done at a time when the number of banks actually declined from 51to 47.
The banks met the increased demand in two ways. First, they expanded laterally by establishing new branches to service new areas and clients. The number of branches increased from 6056 to 7961, i.e. by 31.4 percent during the new millennium. Â Second, and more importantly, the volume of transactions of each branch increased very substantially. At the turn of the millennium, each branch carried deposits of Tk11.6 crore and gave out loans amounting to Tk9.6 crore. By the end of 2011 these amounts rose to Tk55.9 crore and Tk44.0 crore respectively, i.e. nearly five-fold increase in transactions per branch. The fact that these banks were fiercely competing for deposits when BB clamped down on them with a tight monetary policy late last year suggests that these banks have the capacity to grow further by both increasing the amount of transactions of each branch and also increasing the number of branches. The pace of growth of the economy does not indicate that the existing banks are unable to handle the increased volume of transactions, and therefore, does not provide a strong rationale for new banks.
BB mentions in the note that 45 percent of the population of the country remain unbanked. This has little to do with the availability of commercial banking services, but much to do with the financial ability of these people to access such services. It should not be forgotten that nearly one-half of the population of the country are still desperately poor. Most of them do not have a great need to access conventional commercial banking; what they do need and want is adequate means of livelihood or gainful employment. The small amounts of transactions that they may engage in are perhaps not adequate to run commercial bank branches profitably. These are precisely the reasons for the rapid growth of micro-credit institutions that have found innovative ways of providing specialised banking facilities to the poor people, especially women. They have served the banking needs of the poor commendably during the last three decades, which has earned them a worldwide reputation. Â They have the potential to grow further and should be encouraged. Conventional commercial banks are not well suited, and cannot be expected to provide such services without large cross subsidisation. Inclusive banking needs not mean the proliferation of conventional commercial banks.
Most of our poor people live in rural areas. Although 57 percent of the bank branches are located in the rural areas, less than 8 percent of the total advances and 13 percent of deposits originate there. Â It is instructive that commercial bank branches in the rural areas attract on average about one-ninthÂ of the deposits ofÂ a city bank and give out only about one-sixteenth of the loans they disburse in the city areas. The rural bank branches have the capacity to expand several times their current level of operation, but are unable to do so due mainly to demand constraints. Adding more banks will not ameliorate the economic condition of the poor or the unbanked people, but could further reduce the profitability of rural bank branches.
The most egregious arguments that BB has put up in its note are: (i) the new banks will expand the capital base of the banking sector which will enable them to increase the single borrower limit, thus avoiding the need of corporate borrowers to approach several banks for syndicated or participation loans when credit needs are large, and (ii) the entry of new banks will heighten competition in the banking sector which will bring down the interest rate and the interest spread.
It is of course true that the new banks will immediately raise the capital base of the banking sector and enhance its capacity to increase total credit under current monetary regulations and policies. However, the single borrower limit (set by regulation) does not depend on the capital base of the banking sector, but rather on the capital base of the individual bank. Since the new banks will initially have far less capital than the older banks, their single borrower limit will be also correspondingly lower. Indeed, if these banks are involved, a large borrower will have to approach more banks for the same amount of loan than previously. What the new banks could achieve is an expansion of total credit and not credit to individual borrowers. Syndicates for large loans are formed with only a few banks. If a large borrower needs a bigger loan more existing banks could be added to the syndicate; new banks are not needed for this purpose (however, new banks do increase the range of choice). It may be mentioned that one of the principal reasons for syndication is to spread the risks of a large loan; participating banks frequently have the capacity to put up a larger share, but do not do so as they are unwilling to bear greater risk.
Total credit supply by banks has increased more than five-fold during the new millennium when the number of banks declined from 51 to 47. Until recently, the banking system was blithely increasing credit so much so that the inflation rate shot up to double digits. Only a few months ago BB had very deliberately put on a credit squeeze on the banks in a bid to reduce the inflation rate. How does it now argue that new banks are needed for pumping in more credit? This brings to the fore the most appalling aspect of BB reasoning: what really determines the volume of credit? Does BB bank on the number of banks to increase the supply of credit or on its monetary policy? Â In the same vein, is the interest rate determined by the number of banks or the monetary policy? Does BB regard the number of banks to be a new monetary policy tool that can be banked on to increase the credit flow or reduce the interest rate?Â If so what would it do when the reverse is needed?
Monetary policy influences the borrowing and the lending rates similarly. Thus both the lending rate and the deposit rate will fall when the money market is lax, and conversely. An increase in the number of banks, if it raises the amount of credit as argued by BB, would have the same impact. The interest spread is on the other hand determined to a large extent by the operational costs of individual banks. The establishment of new banks could reduce these costs if there were economies of scale in the banking sector. However, industry insiders fear that addition of more banks will increase operational costs of the sector by pushing up personnel and other costs.Â Hence, the interest spread is unlikely to decrease.
BB had initially taken a correct and principled stand as befits a central bank.Â It had to change position later due to overwhelming political pressure. This was apparent to all, and the least BB could have done was not to attempt to justify its volte face with weak economic logic. The BB note is unlikely to have convinced many about the need for new banks, but it has raised questions about its analytical capacity.
M. A. Taslim is a Professor of Economics of the Department of Economics, University of Dhaka. He is currently holding the charge of the Chairman of the Department. He was formerly the Chairman of Bangladesh Tariff Commission.