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Excess liquidity: challenge or opportunity?

Prashanta Kumar Banerjee
BANGLADESH has positioned itself as a forward-looking nation in the world economy through its steady and stable growth performance over the years amid natural calamities, external shock and political turmoil. The growth potential of Bangladesh has been recognised by many global surveys. JP Morgan Chase placed Bangladesh as one of the frontier five markets and Goldman Sachs ranked the country among 11 emerging markets after BRICS (a bloc of Brazil, Russia, India, China and South Africa). The country has also achieved Ba3 and BB ratings with stable outlook in consecutive years (2010-13) by S&P and Moody's, respectively.
Banks through financing production and consumption act as a catalyst in the economic growth of the country. It is also empirically documented because the entire economy of Bangladesh distinctly depends on bank financing leaving other two sources of financing, namely, equity and bond financing underutilised or almost non-utilised. Bank financing has both short- and long-term positive and significant impacts on economic growth. As banks' assets and economic growth have bi-directional causality, bank assets go up congruent with the economic growth of the country. London-based research firm Business Monitor International finds that total banking assets in Bangladesh witnessed a 19.1 percent compound average growth rate in the past five years followed by 18 percent in Sri Lanka, 17.2 percent in Pakistan, and 16.7 percent in India.
But the current excess liquidity of banks is a cause of concern for both policymakers and practitioners. Outstanding bank credit during 2013 rose by He 36,558 crore or 8.88 percent as against an increase of 18.40 percent in 2012 (Bangladesh Bank, Annual Report 2012-1013). This slowdown is partly due to sluggish investment demand in the
lead-up to the national elections, less penetration of bank credit services except in Dhaka and Chittagong, tighter lending practices by banks, reducing investment opportunity in the stockmarket as well as the fact that entrepreneurs can access overseas lenders who offer low-cost financing. As a result, apparently the banking sector is under pressure of excess liquidity. The overall excess liquidity with commercial banks stood atTk 102,223 crore as on May 1, 2014, which is now mostly invested in government approved-securities.
Does this excess liquidity mean that the real economy is flooded with finance and it does not have the capacity to absorb this excess liquidity? If we look at our neighboring countries, we will get a different picture. The percentage of private sector credit to GDP was 68.98 percent in Bangladesh in 2012. However, the corresponding rates were 155.12 percent, 128.7 percent and 75.88 percent in China, Malaysia and India, respectively, at the same time. It indicates that Bangladesh has still more space to increase its bank finance GDP ratio through financing all types of investments, particularly private investment.
Factors like congenial investment climate, good infrastructure, rationalisation of interest rate, openness of the economy, overall growth of GDP, and status of international economy are considered as determinants of growth of private investment, which creates demand for bank financing. Apart from ensuring the above factors, the government's investment in the productive sector is an important driving force for private investment. A large body of empirical studies supports this relationship.
In the 2014-2015 budget, allocation for annual development programme (ADP) has been of a hefty amount of Tk 86,000 crore. Sectors like transport, power, education, physical planning, water supply, housing, rural development, agriculture, and health will get priority in ADP allocation. As these sectors are considered as the promoter of private investment, it is expected that private investment will be revitalised with this investment.
Moreover, many backward and forward linkage industries linked with government investment will get opportunity to expand their business. The global economy is also coming out of the recession era which may encourage the private sector to invest more for participating in international trade. This expected surge in private investment will essentially escalate the demand for bank financing.
Planning for government borrowing from the banking sector on a large scale may also create pressure on banks which will siphon off the current excess liquidity. Apart from this, a hike in CRR (cash-reserve ratio), which may raise interest rate on loans, will also mop up liquidity from the market. However, as supply
sides of loan financing, banks and non-bank financial institutions may also take some steps to create demand for its excess funds. This can be done through ensuring uninterrupted credit flows to the agriculture sector, and small and medium enterprises together with other important existing and new sectors.
Apart from continuation of urban financing at a higher rate, banks may consider ensuring credit flow at a progressive rate in the rural area covering traditionally un-served farm and nonfarm SMEs and other innovative niche area entrepreneurs.
Businesses and productions such as rice bran oil, wooden business, agro-based industry, food industry, floriculture, light engineering and mushroom cultivation are gradually expanding in the semi-urban and rural areas where banks can finance increasingly.
To make the banking system of the country more entrepreneur-friendly, Bangladesh Bank
has undertaken multidimensional initiatives and is working for the implementation of these initiatives.
Creating congenial business environment through controlling macroeconomic indicators, bringing down interest rate spread, introducing more and more refinancing schemes covering new areas of business, offering advocacy services to entrepreneurs, and imparting training to bank employees are some well-known initiatives undertaken by the BB. Bangladesh Institute of Bank Management also plays a supportive role through its training, research and different types of advocacy services. It is expected that these collective initiatives will enable banks to find out the areas and sectors where the current excess liquidity will be utilised.
The writer is the director of research, development and consultancy at Bangladesh Institute of Bank Management.