4pc interest rate spread to hit Bangladesh’s SME sector

Banks that provide a large share of lending to the country’s small and medium-sized enterprise (SME) sector have expressed concern after the Bangladesh Bank abruptly capped the spread between deposit and lending interest rates at 4 per cent.

They warned that the decision could put them under significant pressure, arguing that lending to the SME sector involves the highest operating costs, which cannot be covered with a spread of only 4 per cent.

Bankers said the central bank’s new rule would prompt many banks to reduce fresh lending to the SME sector, which would have a negative impact on the sector as a whole.

Discussions with senior executives from several banks indicate that they plan to request Bangladesh Bank to exempt the SME sector from the 4 per cent spread limit.

The Association of Bankers, Bangladesh (ABB) may submit a letter to the central bank on behalf of its member banks.

Bangladesh Bank recently issued a circular stating that the average spread between deposit and lending interest rates must not exceed 4 per cent.

However, this requirement does not apply to credit cards or consumer loans. The central bank also announced that the directive took effect immediately, requiring banks to revise their interest rates from that day.

In practice, however, banks cannot determine interest rates without holding a meeting of their Asset-Liability Management Committee (ALCO).

Banks normally set lending rates by taking into account deposit costs, operating expenses and a reasonable profit margin.

Officials of Bangladesh Bank told Prothom Alo that the government had instructed the central bank to make interest rates more flexible, prompting it to reduce the spread to 4 per cent.

As the decision was taken without a formal review, it has raised a number of questions. At a time when the government has announced various stimulus packages to accelerate economic activity, a more thorough assessment before taking such a decision would have been preferable.

According to Bangladesh Bank data, the average deposit interest rate stood at 6.24 per cent in April, while the average lending rate reached 11.96 per cent during the same month. The resulting interest rate spread was 5.72 percentage points.

One of the leading lenders to the SME sector is private-sector BRAC Bank. Speaking to Prothom Alo on Sunday, the bank’s Managing Director, Tareq Refat Ullah Khan said, “On average, our cost-to-income ratio is 45 per cent. However, it reaches 65 per cent in the CMSME sector. Lending to this sector involves significantly higher costs. Half of our workforce is dedicated to this segment. It is difficult to recover those costs with a spread of only 4 per cent. We are deeply concerned about the matter. Given the current state of the economy, there is no alternative to expanding lending to this sector. We hope a positive decision will be taken in the national interest.”

A review of banks’ interest rates shows that multinational banks maintain the widest spreads. Some foreign banks record spreads of more than 9 per cent. Among domestic banks, those generating the highest profits also maintain spreads above 4 per cent.

State-owned banks have the lowest spreads, although they still exceed 5.5 per cent. As a result, if banks are to comply with the new spread limit, they will have to reduce lending rates, a move that is expected to have a significant impact on their profitability.

According to information published on the banks’ websites, BRAC Bank and Eastern Bank offer loans at interest rates of up to 14 per cent, while Prime Bank, Pubali Bank, The City Bank, and United Commercial Bank (UCB) charge rates of up to 15 per cent.

As a result, these banks will have to make significant changes to their lending rates to comply with the new directive.

Ahsan Zaman Chowdhury, general secretary of the Association of Bankers, Bangladesh (ABB) and managing director of Trust Bank, told Prothom Alo, “Capping the spread at 4 per cent is a good decision to reduce the cost of doing business. It will lower financing costs for all businesses. Both small and large enterprises will be able to obtain loans at the same rate. The economy needs such a measure. However, many banks will come under pressure, and the decision may also affect their profitability.”

In its directive on the interest rate spread, Bangladesh Bank stated that it had previously withdrawn spread-related regulations after introducing the SMART (six-month moving average rate of treasury bills) framework, under which lending rates were determined based on a reference rate and a margin.

In May 2024, the central bank introduced a fully market-based interest rate regime, and it did not issue any further directives on interest rate spreads after that.

Recently, however, the central bank observed that many banks had set lending rates significantly higher than deposit rates, widening the spread to a level that was hampering business activity and industrial growth.

As state-owned and Islamic banks have seen their lending capacity decline, BRAC Bank, The City Bank, Pubali Bank, United Commercial Bank (UCB) and several other banks have become the leading lenders to the SME sector.

Officials at these banks said that small entrepreneurs are generally more concerned about obtaining loans than about the interest rate.

Since these businesses often generate relatively high profits, higher borrowing costs are usually manageable. However, if banks stop lending, many of these enterprises could be forced to shut down.

Nearly 18 per cent of the banking sector’s total loan portfolio has been disbursed to the cottage, micro, small and medium enterprise (CMSME) sector. The government has set a target of increasing the sector’s share to 27 per cent of total bank lending by 2029.

According to the Ministry of Industries and the SME Foundation, Bangladesh currently has around 11.7 million (1.17 crore) cottage, micro, small and medium enterprises (CMSMEs). Of these, nearly 60 per cent of entrepreneurs remain outside the formal banking credit system.