SV\/P672
Evaluation of Financial Policy
Credit Allocation in Bangladesh
Arvind Virmani
WORLD BANK STAFF WORKING PAPERSNumber 672
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WORLD BANK STAFF WORKING PAPERSNumber 672
Evaluation of Financial Policy
Credit Allocation in Bangladesh
Arvind Virmani
The World BankWashington, D.C., U.S.A.
Copyright (© 1984The International Bank for Reconstructionand Development/THE WORLD BANK1818 H Street, N.W.Washington, D.C. 20433, U.S.A.
All rights reservedManufactured in the United States of AmericaFirst printing October 1984
This is a working document published informally by the World Bank. To presentthe results of research with the least possible delay, the typescript has not beenprepared in accordance with the procedures appropriate to formal printed texts, andthe World Bank accepts no responsibility for errors. The publication is supplied at atoken charge to defray part of the cost of manufacture and distribution.
The World Bank does not accept responsibility for the views expressed herein, whichare those of the author and should not be attributed to the World Bank or to itsaffiliated organizations. The findings, interpretations, and conclusions are the resultsof research supported by the Bank; they do not necessarily represent official policy ofthe Bank. The designations employed, the presentation of material, and any maps usedin this document are solely for the convenience of the reader and do not imply theexpression of any opinion whatsoever on the part of the World Bank or its affiliatesconcerning the legal status of any country, territory, city, area, or of its authorities, orconcerning the delimitation of its boundaries, or national affiliation.
The full range of World Bank publications, both free and for sale, is described in theCatalog of Publications; the continuing research program is outlined in Abstracts ofCurrent Studies. Both booklets are updated annually; the most recent edition of each isavailable without charge from the Publications Sales Unit, Department T, The WorldBank, 1818 H Street, N.W., Washington, D.C. 20433, U.S.A., or from the EuropeanOffice of the Bank, 66 avenue d'I6na, 75116 Paris, France.
Arvind Virmani is an economist in the Development Research Department of theWorld Bank.
Library of Congress Cataloging in Publication Data
Virmani, Arvind, 1949-Evaluation of financial policy.
(World Bank staff working papers ; no. 672)1. Credit control--Bangladesh. 2. Finance--Bangladesh.
I. Title. II. Series.HG3711.B3V57 1984 332.7'09549'2 84-20985ISBN 0-8213-0429-1
Abstract
The Bangladesh Goverrnment has used a variety of policies to
influence the allocation of credit to specific borrower groups like poor
farmers, uses such as housing, and sectors such as agriculture. These
policies have also been used tc reduce allocation for certain uses such
as inventory holding ("speculative purposes"). The policies used have
included interest controls credit guarantees, refinance and margine
requirements. This paper attempts a systematic analysis of all the
policies used by the Bangladesh government in the light of the explicit
or implicit objectives of the government. The effect of each of the
policies used, alone or in combination, is analysed with a view to
evaluating their usefulness and efficiency. The analysis then provides
the basis for suggested policy charges in Bangladesh, as well as lessons
for financial policy makers in other countries.
ABREGE
Le Gouvernement du Bangladesh, souhaitant orienter les pratiquesdu credit bancaire de maniere a favoriser certaines categories d'emprunteurstels que les agriculteurs defavorises et certains secteurs comme le logementet l'agriculture, ou, au contraire, a d6courager le detention de stocks ades fins speculatives, a mis en oeuvre tout un eventail de mesures. C'estainsi qu'il agit notamment sur les taux d'int6r&t, les garanties de creditet les criteres regissant les refinancements et les marges ben6ficiaires.Le present document s'efforce de proc6der a une analyse systematique detoutes les mesures appliquees par le Gouvernement, a la lumiere de sesobjectifs explicites ou implicities. II examine l'impact de chacune deces politiques, utilisee isolement ou en association avec d'autres, afinde juger de son utilit6 et de son efficacit6. Sur la base de cette etudecritique, il propose des modifications et tire un certain nombre deconclusions dont peuvent slinspirer les responsables de la politiquefinanciere d'autres pays.
Extracto
El Gobierno de Bangladesh ha utilizado diversas politicas parainfluir en la asignaci6n del credito a grupos especificos de prestatarios,como los agricultores pobres, iy a ciertos usos y sectores, como la vivienday la agricultura. Estas polit-icas se han utilizado ademas para reducir laasignaci6n del cr6dito a deterrninados usos, como el mantenimiento de exis-tencias ("fines especulativos"). Entre las politicas aplicadas cabe citarel control de los intereses, garantias de creditos, refinanciamiento y exi-gencias de margenes. En este trabajo se intenta hacer un analisis sistema-tico de todas las politicas ap]Licadas por el Gobierno de Bangladesh a la luzde los objetivos explicitos o implicitos del mismo. Se analiza el efecto decada una de las politicas util:izadas, por si sola o en combinaci6n conotras, con vistas a evaluar su utilidad y eficacia. El analisis proporcionaluego la base para sugerir cambios de politicas en Bangladesh, asi como paraextraer ensenianzas de posible utilidad para los responsables de elaborar laspoliticas financieras en otros paises.
CURRENCY EQUIVALENTS
The Bangladesh Taka (abreviated TK) is fixed in relation to abasket of reference currencies, with the Pound Sterling serving asintervention currency. On January 11, 1982, the exchange rate was setat TK 38.372 buying and TK 38.472 selling per Pound Sterling. Dependingon exchange rate movements between Sterling and the US Dollar, theTaka/Dollar cross-rate is subject to change. In recent months, thisrate has fluctuated between TK 19 and TK 20.9 per US$.
MEASURES
1 Crore = 10 million
1 Lakh = 100 thousand
FISCAL YEAR
The Bangladesh Fiscal Year (FY) runs from July 1 to June 30.
Chapter Table of Contents Page
I., Introduction 1
1.1 Objectives - Explicit 1
1.2 Objectives - Implicit 1
1.3 Types of Policies 2
1.4 Overall Allocation 3
II. Interest Rate Policy 8
2.1 First Major Revision 8
2.2 Second Major Revision 8
2.3 Effect of Credit Ceilings 10
2.4 Guarantees and Collateral 11
2.5 Distributional Effects 15
2.6 Speculative Credit 16
2.7 Interest Ceilings and Interest Subsidy 16
2.8 Penalty Interest Rates 17
2.9 Objectives and EfEfects of Second Revision 19
2.10 Intra-Bank Lending Rates 22
2.11 Real and Nominal Interest Rates 23
III. Credit Allocation Polic 24
3.1 Overview 24
3.2 The Target Approach 25
3.3 Ceilings and Prohibitions 30
3.4 Margin Requirements: Overview and Analysis 32
3.5 Margin Requirements: Differential Impact 37
3.6 Refinance and Counter Finance: Overview 47
Table of Contents (continued) Page
3.7 Refinance Usage, Intentive Effects and Usefulness 52
3.8 Guarantee Programs 62
3.9 Urban-Rural Branch Licensing 64
IV. Issues of Financial Policy 69
4.1 Efficiency or Inefficiency in Credit Markets 69
4.2 Welfare Objectives and Credit Markets 70
4.3 Differential Interest Rates: Availability vs. Cost 72
4.4 Financing of Specialized Banks: Refinance, Debentures 73or Deposits
4.5 Buffer Stocks: Alternative for Margin Requirements 79and Refinance
4.6 Term Finance 80
V. Agricultural Credit 81
5.1 Introduction 81
5.2 Expected Marginal Product of Loans 82
5.3 Targets and Disbursements; Differential Performance 85
5.4 The Special Agricultural Program and Commercial 88Bank Performance
5.5 Introduction of Urban Organized Banks into 91Agricultural Lending
5.6 Interest Ceilings and BKB Performance 92
5.7 Recovery Performance 94
5.8 Bad Debts vs. Liquidity Problems 101
Footnotes 103
References 103
List of Tables
Table Number Page
1. Sectoral Distr.Lbution of Advances by 4Scheduled Banks
2. GDP in Current Prices by Sectors 6
3. Credit Allocation Index 7
4. Interest Rates on Loans and Advances 9
5. Advances Classified by Size of Accounts 12
6. Advances Classified by Securities 13
7. Loans to Agricuiltural Hunting, Forestry, 14Fishing
8. Advances Classified by Rates of Interest 18
9. Advances to Small Loans and Small Industry, 27House Building and Transport
10. Rates of Growth of Prices and Imposition 33of Margin Requirements
11. Distribution of Advances by Margins for 38Specified Securities, and Average Loan Sizeby Margin for the same Securities
12. Distribution of Advances by Rates of Margin 40for Related Securities
13. Distribution of Advances by Rates of Margin 41
14. Distribution of Advances by Securities 44
15. Distribution of Advances by Economic Purpose 46
16. Use of Refinancie by Bangladesh Krishi Bank 48(BKB) and Bangladesh Samabya Bank (BSB)
17. Average (weighted) Deposit Rate 53
18. Refinance: Usage as a Percentage of 57Entitled Limits
19. Advances and Deposits of Scheduled Banks 59excluding BKB and BSB
List of Tables (continued) Page
20. Payment of Government Guarantees to the 63Banks Under Special Agricultural Credit Program
21. Rural Branch Expansion 65
22. Administrative Costs of Rural Branches 67
23. Sonali Bank Statistics 68
24. Credit-Deposit Ratio by District 78
25. Marginal Product of Loans in Agriculture 83
26. Agricultural Credit 86
27. Special Agricultural Credit Program 89
28. Bangladesh Krishi Bank Borrower Characteristics 93
List of Figures
1. Rationing Equilibrium 36
2. Recovery Profiles by Banks for the Special 96Agricultural Credit Program
3. Recovery Profiles: BKB, Sonali, Agrani and 97Janata Banks
4. Recovery Profiles: Janata, Uttara, Rupali 98and Pubali Banks
5. Recovery Profiles by SACP Programs 100
DEFINITIONS AND ABREVIATIONS
Bangladesh Bank (BB): The Central Bank of Bangladesh.
Co-operative Banks: Consist of an apex co-operative bank and 62central co-operative banks.
Bangladesh Samabaya Bank Limited (BSBL): The apex co-operative bank;sometimes referred to as the Bangladesh Jatiya Bank (BJSB).
Scheduled Banks: Banks permitted to carry out all normal bankingoperations including the taking of deposits from thepublic. They are therefore subject to reserve requirements.
Nationalized Commercial Banks (NCBs): The six commercial banks(Sonali, Janta, Agrani, Rupali, Pubali, Uttara) owned by thegovernment.
Specialized (Scheduled) Banks: Special Purpose Banks which areallowed to take deposits. Consist of:
Bangladesh Krishi Bank (BKB): The Agricultural development bank;Bangladesh Shilpa Bank (BSB): Specialized bank for making medium
and long term loans to industry.
Foreign Commercial Banks': 'Branches of foreign owned banks.
Bangladesh Shilpa Rin Sangst'ha (BSRS): Specialized Institution formaking long and medium-term loans to heavy-mediumindustries. Not a sc'heduled bank.
House Building Finance Corporation (HBFC): Specialized Institutionfor making loans for Housing.
Integrated Rural Development Program (IRDP): A two-tier co-operative system separate from and independent of the co-operative banks. Financed through the Sonali Bank.
PREFACE
This paper applies thet analytical framework developed earlier
by the author in The Nature of Credit Markets in Developing Countries:
A Framework for Policy Analysis, (World Bank Staff Working Paper
No.524). The paper was prepared originally as a report for the
Bangladesh Financial Sector Review Mission. Many of the issues before
this mission and its objectives were similar to those which motivated
the author's earlier work. The current paper was therefore conceived
from inception as a practical application of this policy framework.
A distinction between empirical testing and practical
application needs to be borne in mind in reading the paper. The former
was not attempted, given the data limitations and time constraints under
which the paper was written. It is presented more as a practical guide
to others wishing to apply the siame framework in the context of similar
limitations.
Arvind Virmani
I. INTRODUCTION
1.1 Objectives - Explicit
The Bangladesh government has outlined three operational objectives
of financial policy. These are-I/
(a) Macro-Economic Objective:
To control the expansion of bank credit so as to contain inflation
while stimulating production and investment. As with most governments no
explicit trade-off is considered and the relative emphasis on one or other
sub-objective has varied with economic and social conditions.
(b) Credit Allocation Objective:
To channel credit into priority and essential sectors and away from
speculative activities and hoarding. Agriculture, small industry and exports
were the earliest sectors to be defined as priority sectors. The emphasis on
agriculture as a priority/essential sector has remained throughout. The
emphasis given to other sectors has varied however. Small industry expanded
to include small businesses and trade, new sectors like residential housing
and Transport were added and then detleted from the list.
(c) Institutional Objective:
To consolidate and strengthen the banking system, to provide new
financial institutions and to promote money markets.
1.2 Objectives - Implicit
Underlying these explicit or apparent objectives of financial policy
are deeper or implicit objectives which guide their application. This is
particularly true of the credit allocation and institutional objectives. The
implicit objectives are:
- 2 -
(a) Efficiency Objective:
To correct imperfections in the credit market which lead to
economically or socially inefficient use of credit. This clearly influences
the choice of sectors and borrower categories for both positive and negative
credit allocation measures. It also influences the institutional objectives.
(b) Welfare Objective:
To provide welfare subsidies to target groups, to transfer income
between different groups of borrowers, and to change the division of gains in
transactions between traditional lenders and borrowers.
(c) Subsidy Objective:
To correct imperfections or impediments in other markets, or to
mitigate these effects, by providing subsidies through the credit system.
1.3 Types of Policies
The most important financial policies used to meet the overall
objectives can be divided broadly into three groups. This is done on the
basis of the sub-set of the objectives they are primarily directed towards.
They can and often do have effects on other objectives, but it is useful as a
first step to make the categorisation, as follows:
(a) Credit Ceilings and Prohibitions:
These were directed primarily at controlling the flow of total
credit, but often have an allocation component. They include ceilings on
total lending by individual banks, lending to private and public sectors,
lending to different loan size classes, and lending for certain economic
purposes. The allocation component is designed primarily to countervene the
likely allocational impact of overall credit control policies.
-3 -
(b) Allocational Instruments-
These included lending targets and guidelines, margin requirements,
refinance policies, government guarantees, and linking to new urban and rural
branches. Specialized banks when coupled with refinance policy have been
another instrument for this purpose. Further the effects of refinance policy
have been most strongly influenced by the credit ceiling instrument.
(c) Int:erest Rate Policy:
Interest rate policies, including the use of penalty rates, of
course have the broadest ramifications. Ceillgns on (loan) interest rates
have been directed primarily towards the welfare and subsidy objectives. A
secondary objective has beenm the stimulation of investment. Interest rate
policies of course influence the allocation of credit, and the viability of
financial institutions. The use of penalty rates of interest on loan
overdues, has been used as an indirect means of couiiteracti g some of these
secondary effects.
1.4 Overall Allocation
The present paper focuses on the post 1975 period, and on the issue
of credit allocation. Clearly however issues can seldom be so neatly
compartmentalized. To the extent that Macro-economi and institutional issues
interact with credit allocation Issues they will be dealt with.
Table 1 gives an overview of the allocation of credit by broad
economic sectors. Over the period from June 1975 to December 1975 the
proportion of total advances to the agricultural sector rose from 10.8% to
18.6%, while those to manufacturin;v declined from 52.4% to 40.0%. The
proportion of advances going to the transport eector also showed a declining
trend while those to the construction sector in reased. The proportion of
advances going to wholesale and retail trade fluctuated considerably over the
Table 1: Sectoral Distribution of Advances by Scheduled Banks
(Percentage of Total)
Sectors 30-6-75 30-6-76 30-6-77 30-6-78 30-6-79 30-6- 80
Agriculture, Forestry, Fishing 10.76 10.78 11.31 14.13 16.65 18.59
Manufacturing 52.38 48.73 43.81 42.76 40.12 40.02
Construction .76 .69 1.14 1.37 2.67 1.43
Transport and Communications 3.56 4.89 3.93 3.86 3.62 3.17
Transport 4.31 4.87 3.89 3.82 3.50 3.14
Trade and Catering 23.59 27.50 27.64 22.94 26.18 25.82
Trade-Wholesale and retail 23.09 26.65 27.23 22.71 25.98 25.60
Jute goods and Tea + 11.80 6.43 6.29 9.48 9.32
+ Data not available.
Source: Calculated from Bangladesh Bank Bulletin.
- 5 -
period. These figures suggest a redirection of credit away from transport and
communication and manufacturing, into construction and agriculture, forestry
and fishing.
Table 2 shows however that the share of the different sectors in
total GDP varied considerably over time. Any shifts in the pattern of credit
allocation between sectors would therefore be partly due to changes in GDP
share and partly to government policy and other factors. It is therefore
useful to construct an index which removes this effect, and is presented in
Table 3. The doubling of the index for agriculture over this period confirms
the profound shift of institutiona)l credit towards the agricultural sector.
The index for the transport and communication sector also continues to show a
down trend over the whole period. None of the other sectors now show a clear
trend over the entire period, with the construction sector replacing the trade
and catering sector as the most erratic.
The only other information of note in Table 3 is the kink which
occurs in the index for Trade and Catering in June 1978. Trade and Catering
follow the inverse sawtooth pattern with the rising trend interrupted by a
full in 1977-78. It is likely that a general reduction in loan interest
ceilings in May 1977 is responsible for this effect which occured between .June
1977 and June 1978.
Table 2: GDP in Current Prices, by Sectors (Percentage)
GDP in Market Prices 1974-75 1975-76 1977-76 1977-78 1978-79 1979-80
Agriculture, Forestry, Fishing 62.53 53.36 50.94 55.45 54.39 54.10
Manufacturing 6.66 7.61 8.22 7.22 7.12 7.25
Construction 4.51 5.13 5.51 4.72 4.25 5.39
Transport and Communications 4.49 6.17 6.96 6.77 6.59 6.68
Trade & Catering 8.73 10.00 9.86 9.85 10.80 11.05
Soulrce: "Bangladesh: Recent Economic Dlevelopments and Selected Development Issues,"' March 3, 1982.(This is an internal document with restricted circulation.)
Table 3: Credit Allocation Index; Ratio of Advance Proportions to GD? Proportions
1974-75 1975-76 1976-77 1977-78 1978-79 1979-80
Sector
Agriculture .172 .201 .222 .255 .306 .344
Manufacturing 7.865 6.403 5.330 5.922 5.635 5.520
Construction .168 .135 .207 .290 .628 .265
Transportation .793 .793 .565 .570 .549 .475
Trade 2.702 2.750 2.803 2,329 2.424 2.337
Source: Tables 1 and 2.
II. INTEREST RATE POLICY
2.1 First Major Revision
Table 4 gives an overview of changes in interest rate ceilings on
loans and advances. Over the period there have been two major changes in loan
interest ceilings. The one in May 1977 reduced the nominal ceilings on almost
all loans by one percentage point; from 13% to 12% on general borrowing and
from 11.5 to 10.5 on exports. The exceptions to this were the rates on Jute,
Jute goods and Tea and rates charged by the specialised banks and co-
operatives, which remained essentially unchanged. The effect of this way to
reduce the gap between the interest charged by these institutions and by
others, with the exception of the Bangladesh Samabaya Bank (BSB).
Interestingly BSB which makes medium to long-term loans retained a higher
ceiling rate of 13%.
The professed objective of this reduction in ceilings was to provide
a stimulus to economic activity, particularly to commerce and trade. Credit
ceilings had been in effect since the IMF borrowing in 1974-74. These had
been raised periodically. In particular they had been raised some months
before the lowering of the interest rate ceilings. Credit ceilings were
therefore not on effective constraint in the succeeding period. In 1975-76
and 1976-77 the implicit GDP deflator declined by 23.9% and 3.2% respectively
indicating a strong though decelerating deflation. In 1977-78 this process
was reversed by an inflation rate of 14.9%.
2.2 Second Major Revision
The other major change in interest rate policy occured in October
1980 (also Table 4). The effect of this set of changes was to differentiate
loan interest ceilings by economic sectors. Thus intra-sectoral rates were
unified while intersectoral ceilings were made different for agriculture and
Table 4: Interest Rates on Loans and Advances (Scheduled Banks)
Since Since SinceJuly 1974 July 1976 May 1977 1978/79 October 1980 1981
General Borrowers 12.0-13.0% * 11.0-12.0% * 15.5% 16.0(i.e. all those notseparately specified)
Export Commodities 12.0-13.0% 11.5% 10.5% * 12.0% *(except Jute, JuteGoods and Tea)
Industry 12.0-13.0% * 11.0-12.0% * 14.0% 14.5% 1/
BSB General Lending 12.0-13.0% * 11.5-13.0% * 14.0%
Agriculture 12.0-13.0% * 11.0-12.0% * 19n0% *
Jute, Jute Goods andTea 10.5% * * * 12.0% *
BKB 11.0-11.5% * * * 12.0% *
Co-Operatives 12.0% * * * 12.0% *
Loans for Socio-EconomicPurposes 12.0-13.0% 12.0% 2/ 11.0% 11.0-11.5% 13.0% *
Bangladesh Bank Rate 8.0% 2/ * * * 10.5%(Discount Rate)
Concessional Discount 6.0% 3/ * * * *Rate for lending toBKB and BSB
X Unchanged from previous period.1/ Except Long term loans which remain at 14%.2/ Effective June 1974.31 Effective September 1976.
BKB: Bangladesh Krishi BankBSB: Bangladesh Samabaya Bank
10
industry. The lowest ceiling was on agricultural advances at 12%, followed by
industry at 14% and all others at 15.5%. One exception to this classification
were loans for socia-economic objectives which had an overall interesst rate
ceiling of 13%. The other apparent exception was export credit (pre-shipment,
packing and post-shipment) at 12%. However interest ceilings on export
commodities had always been relatively low. Jute, Jute goods and Tea were
traditionally the most important export commodities and agricultural exports
continue to constitute the majority of exports. Thus the rise in the ceiling
rate on export commodities can be seen as consistent with intra-sectoral
unification of ceilings.
This revision in the interest rate structure was designed primarily
as a resource mobilisation measure. It was hoped that the increase in the
relative return to an asset competing with speculative stocking activities
would shift assets out of the latter, and thus reduce inflationary
expectations. However it was also expected to result in more efficient use of
credit. Though in the case of both major changes in interest policy the
primary objectives were macro-economic, the effects on credit allocations were
equally if not more important. It is on these we focus.
2.3 Effect of Credit Ceilings
In case of credit for productive purposes, I have shown earlier 2/
that an effective ceiling on loan interest rates would reduce loan amounts and
increase collateral requirements. This effect would be stronger for thse who
were just meeting credit requirements but now run into a collateral
constraint. T1hose who are already constrained by collateral may get no loans
at all. The funds thus made surplus reduce the opportunity cost of funds.
This reduces the direct impact and also results in loans being provided for
the first time to less productive borrowers having sufficient collateral. The
- 11 -
net effect is to shift credit from those having less collaterable wealth to
those with more.
In Tables 1 and 3 it was noted that there was no significant change
in trends of credit allocation to productive (non-trade) sectors between June
1977 and June 1978. As there is no particular reason to expect the
availability of effective collateral to differ significantly across sectors
the facts are consistent with our analysis. Table 5 shows that between June
1977 and June 1978 there was a small but significant increase in the
proportion of loans going to smaller borrowers. Thus the proportion of loans
in the TK 1000 to TK 3000 category increased from 4.44 to 5.79% while
proportion of total loans iln size less than TK 3000 increased from 8.82% to
10.31% (see also section 2,5). The previous analysis suggests that this may
represent a shift of credit to somewhat less productive small producers who
however had sufficient collateral available. This is consistent with the
usual observation that small (indiustrial) producers have lower debt-equity
ratio.
2.4 Guarantees and Collateral
Table 6 gives a distribution of credit by securities. What is
surprising in this table is the slharp decreases, from TK 143 crores on June
1977 to T1K 23 crores on June 1978, in the use of machinery and other fixed
assets as security. As such assets are most prevalent in manufacturing this
would suggest a decline in loans to the manufacturing sector. This conclusion
is contradicted by the data in Tables 1 and 3, however. The correct
explanation is found in the corresponding, and even sharper, increase from
TK 252 crores to TK 509 crores, in use of miscellaneous securities over the
same period. This category includes other secured advances, advances secured
by guarantees and unsecured advances. In 1976-77 TK 56.5 crores of advances
- 12 -
Table 5: Advances Classified by Size of Accounts - All Banks
(% of all Loans)
Loan Size (Taka) 30-6-Z5 30-6-76 30-6-77 30-6-78 30-6-79 30-6-80
< 1,000 4.66 3.63 4.38 4.52 3.16 2.73
1,000 to < 3,000 3.73 3.53 4.44 5.79 6.97 7.64
3,000 to < 10,000 1.45 2.21 2.03 2.09 2.16 2.04
10,000 to < 25,000 1.67* 1.56* 2.50 2.34 2.73 2.36
25,000 to < 50,000 2.49* 2.91* 2.43 2.68 2.15 1.77
50,000 to < 100,000 3.16 3.40 4.78 3.98 4.12 3.13
100,000 to< 10,000,000 14.10 14.00 15.20 17.55 16.74 16.54
> 1,000,000 68.74 68.76 64.24 61.05 61.97 63.79
Cummulative %
< 1,000 4.66 3.63 4.38 4.52 3.16 2.74
< 3,000 8.39 7.16 8.82 10.31 10.13 10.37
< 10,000 9.84 9.37 10.85 12.40 12.29 12.41
< 25,000 11.51* 10.93* 13.35 14.74 15.02 14.77
< 50,000 14.00 13.84 13.35 14.74 15.02 14.77
< 100,000 17.16 17.24 20.56 21.40 21.29 19.67
< 1,000,000 31.26 31.24 35.76 38.95 38.03 '36.21
Total 100.00 100.00 100.00 100.00 100.00 100.00
* 10,000 to 20,000** 20,000 to 50,000+ < 20,000
Source: Bangladesh Bank Bulletin pp. 24-25.
Table 6: Advances Classified by Securities - All Banks
30-6-75 30-6-76 30-6-77 30-6-78 30-6-79 30-6-80
A. Gold etc. 0.47 0.67 0.95 0.95 0.92
B. Stock Exchange Sec. 0.96 1.08 1.02 0.23 1.31 0.68
C. Merchandise 57.86 58.03 53.98 52.90 60.60 62.63
i. Export Commodities 33.26 26.01 20.77 22.55 30.52 31.99ii. Imported intermediaries 13.69 23.13 23.27 20.94 18.43 16.11
iii. Imported Ind. Machineries 10.41 8.40 9.77 8.54 11.34 14.16iv. Imported Agric. Products
nDe MAchiner- ar.d Other Fixed 14.87 1,.01 12.4, 1.57 2.10% 1.89
E. Real Estate 8.12 6.77 7.25 7.15 7.69 7.69
F. Financial Obligations 2.50 2.65
G. Miscellaneous 16.32 16.75 21.85 35.16 24.82 24.18
Source: Bangladesh Bank Bulletin, pp. 58-59.
- 14 -
Table 7: Loans to Agriculture, Hunting, Forestry and Fishing:Classified by Size of Accounts
Size of Account (Taka) 30-6-76 30-6-77 30-6-78 30-9-78 30-6-79 30-9=80
- Loan amounts (1,000 Takas)
< 10OO0 3361.10 4780.19 6083.06 6593.65 5298.45 6592.211,000 to < 3,000 2616.34 4268.14 7617.50 7027.70 11629.47 18675.553,0O0 to < 10,000 102.82 242.62 809.05 897.46 1648.02 2456.0310,000 to < 20,000 63.93 40.46 316.29 469.36 1081.76 3096.7520,000 to < 50,000 49.97 90.32 230.32 345.86 624.73 636.4950,000 to < 100,000 76.95 216.11 143.01 340.34 395.77 455.01> 1,000,000D 3838.93 3409.85 5852.91 6822.76 10542.71 18357.15
Total 10112.68 13047.69 21052.14 22497.13 31220.91 50269.19
Proportion of Total Loans (%)
<( 1,000 33.24 36.64 28.90 29.31 16.97 13.111,000 to < 3,000 25.87 32.71 36.18 31.24 37.25 37.153,000 to < 10 000 1.07 1.86 3.84 3.99 5.28 4.8910,000 to < 20,000 .63 .31 1.50 2.09 3.46 6.1620,000 to < 50,000 .49 .69 1.09 1.54 2.00 1.2750,000 to < 100,000 .76 1.66 .68 1.51 1.27 .91> 100,000 37.96 26.13 27.80 30.33 33.77 36.52
Total 100.00 100.00 100.00 100.00 100.00 100.00
Cumulative Propotio~n(.
< 1,000 33.24 36.64 28.90 29.31 16.97 13.11< 3,000 59.11 69.35 65.08 60.55 54.22 50.26< 10OO 60.18 71.21 68.92 64.54 59.50 55.15< 2-OGO- 60.81 71.52 70.42 66.63 62.96 61.31< 50,000 61.30 72.21 71.51 68.17 64.96 62.58< 100,000 62.06 73.87 72.19 69.68 66.23 63.49
Total 100.00 100.00 100.00 100.00 100.00 100.00
Source: Bangladesh Bank Bulletins
- 15 -
to the public sector Jute industry were rescheduled. This was followed in
1977-78 by rescheduling and restructuring of the debt of the public sector
Jute and Tea industry. This was done under the condition that the debt would
now be backed by government guarantees. The change in the nature of
securities therefore primarily represents a reclassification of this debt from
fixed capital as collateral to government guarantees as collateral.
2.5 Distributional Effects
The distributional effects of credit ceilings, arising from the
unequal distribution of wealth and consequently of collateral among households
are best demonstrated for the agricultural sector. In this sector there is a
high co-relation between the distribution of land and the distribution of
wealth. land is of course the best form of implicit or explicit collateral in
agriculture. In addition, productivity and credit requirements would also be
linked to the value of land. Therefore among the land owners we would expect
small landowners to obtain smaller loans, while most of the landless creditors
would fall in the smallest category.
Table 7 gives the allocation of credit to the agricultural sector,
by loan size. Between June 1.977 and June 1978 there was a sharp reduction in
the proportion of loans of less than TK 1000 from 36.6% to 28.9%. Some of
these were shifted into the next loan size category of TIC 1000 to TK 3000,
which increased from 32.7% to 36.2%. However the table of cumulative
percentages shows clearly the decrease in the proportion of total loans going
to smaller loan categories. As our analysis indicated this would be the
direct effect of a decrease in interest ceiling. A word of caution is in
order, however: As the loan classes are in monetary terms, a proportional
increase in the size of all loans, for example due to inflation, would shift
the entire distribution to higher loan sizes. This would result in a
- 16 -
reduction of the proportion of loans in the lowest and a rise in that of the
highest size classification. The proportions in the other loan size groups
would remain approximately the same. This is not however the pattern in Table
7. Otherwise a Gini type coefficient is to be preferred.
2.6 Speculative Credit
An analysis of pure speculative credit is somewhat different from
that of productive credit as applied above. The speculator/trader is assumed
to use his own funds as well as any borrowed funds for buying a commodity
stock. The return to this stock arises purely from the anticipated increase
in its price. In effect we separate out the productive aspects of trade from
this analysis. The traders own contribution or margin constitutes the
security or collateral as far as the bank is concerned. It can be shown that
a reduction in credit ceilings in this case will tend to eliminate credit for
the less speculative commodities: That is the commodities for which price
rises are expected to be low may not obtain any credit.
In tables 1 and 3 and the accompanying discussion it was pointed out
that the reduction in credit ceilings in May 1977 led to a downward kink in
the rising share of output-adjusted credit going to the trade sector. This is
consistent with the above analysis.
2.7 Interest Ceilings and Interest Subsidy
It is useful at this point to draw a distinction between interest
ceilings and interest subsidies. Both may be motivated by a desire to provide
subsidies, as for example the lower than average credit ceilings on Jute, Jute
goods and Tea and on other export goods which prevailed before October 1980
(Table 4). However they can have quite different effects on the efficiency of
credit use and on the distribution of credit. As already indicated interest
ceilings have negative consequences in both these cases. On the other hand,
- 17 -
that when the banking system is inefficient in allocating credit to specific
sub-sectors or sets of borrowers, an interest subsidy to the bank can remove
this inefficiency [see Virmani (1982)]. In such a situation an interest
subsidy increases loans to the neglected sector and to borrowers with
inadequate collateral (wealth). However this policy has not been tried in
Bangladesh.
2.8 Penalty Interest Rates
In February 1979 the government introduced a system of penalty rates
of interest on overdue loans. Scheduled banks were allowed under the system,
to charge a penalty rate of interest, which could be incremented by 1% every
month, until total rate (normal plus penalty) became 20%. The objective of
this penalty was to decrease the disincentive for lending to sectors where
repayment of loans has been a problem. Loan overdues can create a liquidity
problem in addition to reducing the expected return to the bank. As borrowers
who are delaying payments are likely to be the more risky customers it is
logical to charge them a higher rate. The penalty rate does this without
imposing a cost on good borrowers and is therefore an efficient mechanism for
doing so.
The application of penalty rates, particularly in agriculture, has
been somewhat erratic, with differeni: banks having different rules. Thus
Sonali bank charges the full penalty while BKB limits itself to a maximum
penalty rate of 2.5% and Pubali to 11'. It is also reported that in other
economic sectors, banks often charge penalty rates only to the public sector
borrowers and seldom to the private sector. However this is quite consistent
with the rationale given above, if the public sector is more erratic and
deficient in its repayment performance than the corresponding private sector
borrowers.
Table 8: Advances Classif ied by Rates of Interest All Banks(Percent of total Loans)
30-6-76 30-6-77 30-6-78 30-6-79 30-6-80
Interest Rate
110,0%: 0.19 0.28 0.15 6.79 0.12 0.11
10.5% 26.41 23.31 16.34 18.93 25.25 19,86
11.0% 1.78 1.68 3.49 6.79 7.40 10.20
11.5- 7.28 5.85 5.87 5.49 8;38 7.26
12.O% 16.10 15.66 41.52 38,39 38.10 37.56
> 12.0 to < 13.0% 2.37 2.53 1,32 1.19 0.69 0,53 H
13.0% 33.38 40.57 17.46 9.04 5.01 3.89
> 13.0% 0 0 0 0.07 3.80 3.29
- 19 -
Table 8, giving the disl:ribution of advances by rate of interest,
shows that the proportion of loans carrying a rate of interest rate of more
than 13% jumped from .07% of total advances in June 1978 to 3.8% in June
1979. They remained at approximately that level in June 1980. A small
proportion of these of course constitute high interest loans under the Rural
Finance Experimental Project. The rest are due to the use of penalty rates
and give an approximate measure of the extent of usage of such rates.
As late repayment is a major problem in the agricultural sector,
penalty rates will be discussed further under agricultural credit. Such rates
can be a very useful instrument of policy, when the repayment period is
carefully defined to take account of natural agricultural fluctuations.
2.9 Objectives and Effects of the Second Revision
Detailed data of the kind used above is not available for June , so
the effects of the October 1980 revision of interest ceilings are not fully
visible. However some preliminary conclusions can be drawn. As previously
noted this revision involved a change-over to a sectorally oriented system of
interest ceilings. This involved the setting up of an implicit hierarchy of
sectors; agriculture and exports are on top with a ceiling rate of 12%,
followed by manufacturing with a ceiling of 14%, while all other sectors have
a ceiling rate of 15.5%. Small loans and loans in less developed areas, which
do not fit into the sectoral classiLfication, fall between the ceiling rates
for the agricultural and the manufacturing sectors, with a ceiling rate of
13%.
There are two possible justifications for this hierarchy. One is
based on the supposition that production and investment are sufficiently
sensitive to interest rates, and that the economic rate of return has the
hierarchical pattern postulated. T'hrough a plausible case can be made for the
- 20 -
second proposition, the first is highly dubious. However even if it has some
merit it must be questioned whether the provision of implicit subsidies to
creditors is the appropriate means of providing incentives. Thus it is
necessary to look more closely at other policies, like exchange rates and
tariffs, which directly affect exports and manufacturing.
The other possible justification is to provide welfare subsidies to
target groups. Thus the largest numbers of poor are thought to be in the
rural areas, and lower interest rates to agricultural creditors may be thought
of as providing a subsidy. However even if these justifications are accepted
credit ceilings can have unexpected and harmful effects. To understand this
it is very important to draw a distinction between interest ceilings and
interest subsidies, and between cheaper credit and sufficient credit.
Many policy makers and even economic analysts may see the
differential interest rate ceilings as a cross-subsidisation scheme from
general creditors to farmers, exporters, small loanees and industrial
borrowers. This is quite misleading. A true cross subsidisation scheme would
involve an interest tax (or a tax per loan) on all bank lending to general
borrowers and an appropriate interest subsidy (or subsidy per loan) on the
favoured borrowers. This would provide the correct incentives for channeling
credit into the desired sectors. The effect of the differential credit
ceilings will be to redirect credit away from agriculture and exports and to a
lesser extent from industry into general lending. This perverse effect would
be accompanied by redirection of credit within each sector to those with
sufficient collateral and away from those with little collateral. Thus the
poor would tend to get relatively less credit than they would in the absence
of effective credit ceilings. Though adverse intersectoral flows may be
partly stemmed by forced lending through specification of targets, this has
- 21 -
its own limitations. Among these are ineffectiveness against adverse
distributional effects and the fungability problem (discussed in a later
section).
Two observed effects of the differential credit ceiling support the
above analysis. Firstly these havre a differential impact among the
Nationalized Commercial Banks (NCBs). A rise in deposit interest rates also
raises the interest costs of all banks, and may have a differential impact
across banks depending on the distribution of each bank's deposits.
Profitability is more strongly affected, however, by the sectoral distribution
of a bank-s existing loan portfolio. Thus the Pubali Bank which was strongly
oriented towards small loans, exports and fisheries will now earn 12% or 13%
on most of its loans. This has put a profit squeeze and provided a
disincentive to expand further into these sectors. Thus, it is being forced
to expand into areas of related expertise in industry and trade in which
higher interest rates are allowed.
A similar reduction in profits is taking place for the specialized
banks such as the Bangladesh Krishi Bank (BKB). Though the rise in deposit
rates affects only a small fraction of its funds, the relative profitability
of agricultural lending vis a vis agriculture related commercial lending has
declined. Given that in 1979 approximately 70% of its loans went to
agriculture the lower interest rate of 12% on such loans puts a profit squeeze
on the BKB (discussed further in agricultural section). As a result the BKB
is planning to reduce the proportion of agricultural loans to 60% and to
expand faster into sectors like agro-industries, storage, transport and
banking to which higher credit ceilings are applicable.
- 22 -
2.10 Intra-Bank Lending Rates
The rates charged by banks on their internal transfer of funds
between branches and between branches and headquarters are of course not
directly relevant to final borrowers. They affect the incentive structure of
banks, however, and can affect credit flows to final borrowers. For
commercial banks, these rates vary from 11% to 14% at the present time, as
shown below
Bank Headquarters to Branch Branch to Headquarters
Sonali 11% 11%
Janata and Agrani 12% 12%
Pubali 14% 13%
Thus Pubali bank branches have clearly no incentive to borrow funds from
headquarters for lending to agricultural and export sectors (12%) and for
socioeconomic purposes (13%), and little incentives for lending to industry
(14%). If the average administrative costs for all lending operations (1 to
2%) are taken account of, even Sonali bank branches have little or no
incentive to borrow internally for lending to these sectors.
Banks should of course be free to set intra-bank lending rates
according to their particular circumstances. Given the current structure of
interest rates, however, we can calculate the approximate range in which these
rates should lie. The average interest cost of deposits is currently about 7%
of total business. The average administrative costs of lending are about 4%,
though the administrative costs of rural lending by commercial banks are
somewhat higher at about 5%. As the lowest loan rate is 12%, and taking the
4% cost as divided equally between the deposit and lending sides intra-bank
lending rates should be approximately 9 to 10%.
- 23 -
2.11 Real and Nominal Interest Rates
The anlysis presented in this chapter, as in the rest of the paper,
is in nominal interest rate terms. Given the established practice of using a
rate constructed by subtracting actual or expected inflation from the nominal
rate (the 'real' rate) this requires an explanation. The framework on which
the analysis of the paper is based, divides the basic financial market into
two submarkets: The deposit marlket and the loan market. The former is
supplied with funds by depositors and has banks as demanders of funds. In
conventional terms this is the savings side of the market. When savings are
treated in aggregate clearly a 'real' rate of interest must be used in the
analysis. If deposit markets are perfect, changes in the rate of inflation
have no effect on aggregate saving. If deposit rates are controlled by the
government, however, changes in ithe rate of inflation will influence both the
total amount of savings and the amount flowing into deposits. This in turn
will affect the opportunity shadow cost of funds to the banks (termed s in the
present paper).
our analysis focuses on the loan sub-market. The shadow
(opportunity) cost of funds (s) is of curse an input into this market. In the
loan market, competitive banks will make a loan to a borrower as long as their
expected profits are positive; the loan amount, the loan interest rate and
other variables are all expressed in nominal terms. The firm similarly
maximizes its expected profit evaluated in nominal terms. In deciding whether
to take a loan or not it merely compares these net profits with the nominal
opportunity cost of own funds. The terms of the loan contract, including the
loan interest rate, will differ for firms with different characteristics (e.g.
returns). The allocation of loans will therefore be determined by the
distribution of these characteristics across firms. If we compare two
- 24 -
situations; one in which all prices are double that in the other, there is no
reason to expect any difference in the distribution of these characteristics
across firms. Therefore the allocation of credit should not be affected if
other things remain unchanged.
If the deposit interest rate is controlled, however, the flow of
deposits into the banking system might fall. This in turn would raise the
shadow cost of funds to the banks. Our analysis shows that in this case loan
amounts must fall and loan interests rates rise for every existing borrower.
In addition collateral requirements may rise or fall for each borrower, and
this could affect the distribution of loans. Without more detailed
information, however, it is not possible to determine the direction of change
for any particular borrower. The first order approximation is therefore to
assume no effect of inflation on credit allocations; the analysis can be
carried out in nominal terms.
III. CREDIT ALLOCATION POLICY
3.1 Overview
Several different policy instruments have been used for different
sectors at different times. Among these are targets, prohibitions and
ceilings, margin requirements, refinance or counter finance, guarantees and
urban-rural branch approval. One way of organizing these instruments is in
terms of positive and negative instruments. The negative instruments are
designed to reduce or eliminate the flow of credit to certain individuals or
for certain purposes. Ceiling and prohibitions and margin requirements fall
into this category. The positive instruments are designed to channel the flow
of credit into specified areas. All the other instruments mentioned fall into
this category. Logically of course the categories are complementary in the
- 25 -
sense that if a negative instrunient is successful it must have a positive
aggregate effect on the unspecified areas, and similarly for a positive
instrument.
The banking system (i.e. the financial system excluding the Central
Bank and the government) can be conceptually seen as having an inflow of funds
on the deposit side and an outflow of funds on the loan side. In other words,
instruments can be classified in terms of how far they are from the final
borrower. Right on the outflow side are instruments like lending targets,
lending ceilings and prohibitions, exemptions from overall credit ceilings,
and margin requirements. In the middle are collateral guarantees and urban-
rural linked branch expansion. Farthest away, on the inflow side, are
instruments like refinance and liquidity guarantees.
3.2 The Target Approach
Loans to small businesses, small loans and exports were the earliest
to be designated as priority sectors (1973). In February 1975 banks were
notified that the small loan category be given priority in any credit
allocation following from an increase in deposits. In September 1975 a
lending target of TK 1 crore per bank was fixed for nationalised commercial
banks' lending to this category. During the same financial year (1975-76)
restrictions on housing loans were lifted.
In 1976-77, deposit-linked targets were imposed on each nationalised
commercial bank. The targets were 1 1/2% of deposits (as on June 1976) to be
loaned to the small loan category, 1 1/2% to the transport sector, and 1% of
deposits for residential housing. Informal guidelines were also issued for
increased lending in less developed areas at a controlled rate one percent
below the general interest rate ceilings (i.e. initially at 12%). In 1977-78,
the loan target for small loans was raised to 2% and maintained at that level
- 26 -
for the next three years. In contrast, targets for house building and
transport were maintained at the same level in 1977-78 and then eliminated the
following year. In 1977-78 loan interest ceilings of 11% on loans for rural
housing and 5% on loans for multistoried buildings were imposed. These
compared with the general ceiling of 12%.
Table 9 shows, for the three nationalised commercial banks the loans
made to the three targeted sectors as a percentage of their total loans and as
a percentage of target. The data for the three banks suggest that banks were
quite successful in meeting the small loan targets, but not those for housing
and transport. There is some variation among banks however: Sonali bank was
successful in small loans and unsuccessful in the other two; Agrani bank was
successful in transport and partially unsuccessful in small loans and housing;
and Janta bank was successful in both small loans and transport.
This variability in success (as measured against targets) suggests
that it is not useful to impose uniform targets on banks. Each bank has its
own special orientation and expertise. Given the different sources of
information and information links the banks would tend to specialise in
special segments. Uniform targets reduce the flexibility of the system. A
recognition of this probably lead to the elimination of targets on house
building and transport loans after a trail period of two years.
Table 9 also gives the allocation of credit to each priority sector
as a proportion of the total advances of each bank. In table 1, the share of
advances of all scheduled banks going to the transport sector showed a
declining trend over the 1978-80 period; it went from 4.3% in 1975 to 3.1%. in
1980. The allocation of credit by the three commercial banks in table 9, is
_ 27 -
Table 9: Advanees to Small toans rnd Smatl Tndtstry. HouRse Pu1ldfnr andTransport as a proportion of targeted amounts - Three Banks
kec. 1975 Dec. 1976 Dec. 1977 Dec. 1978 Dec. 1979 Dec. 19801. SONALI BANK (S)
Small loan. and small lndustryAs a percentage of total advanceti 2.19 2.o9 2.44 2.72 2.43 2.25As percentage of target: N.A. 701.00 126.56 109.51 97.82 98.80
House Building
Percentage of total advances .07 .17 .46 .74 .64 .54Percentage of target IIA. N.A. 36.46 59.55 N.A. N.A.
Trans porlt
As a percentage of total advanceo .82 .89 .71 .94 .49 .37As a percentage of target. NA. N.A. 36.89 50.26 N.A. NA.
2. AGRANI BANK (A)
Small loans
As a percentage of total advanceis .80 1.91 3.63 2.43 1.61 1.38As a percentage of target N.A. 291.00 201.18 95.67 62.47 53.15
Rouse Building
As percentage of total advances a .07 .91 1.29 1.26 2.13As percentage of target N.A. N.A. 75.34 101.48 N.A. N.A.
Transport
is percentage of total advance. * 1.14 1.18 1.27 1.00 1.10as percentage of target N.A. N.A. 65.54 67.02 N.A. .A.
3. JANATA BANK (J)
small Loans
As percentage of total advances .0 1.71 1.87 2.59 2.19 *As percentage of target N.A. 608.00 117.91 129.77 112.09 a
Rouse Building
As percentage of total advances a * * .89 1.56 *As percentage of target N.A. N.A. C 89.03 N.A. N.A.
Traaport
As percentage of total advances 2.72 2.11 1.89 1.92 1.91 aAs percentage of target N.A. N.A. 118.89 128.67 N.A. N.A.
4. ThREE BANKS (S. J, A)
Smll Loana (S, J, A)
As percentage of total advances .96 1.45 2.43 2.61 2.18 aAs percentage of target V.A. 364.00 138.58 114.02 95.71 a
House building (S & A only)
A percentage of total advances a .13 .63 .93 .83 .98As percentage of target N.A. N.A. 49.97 74.09 N.A. N.A.
Transport (S, J, A)
As percentage of total advances a 1.52 1.33 1.42 1.16 aAs percentage of target N.A. N.A. 75.84 83.04 N.A. N.A.
N.A. a Not applicablea - Data not availableSorce: Annual Reports of the respective banks
- 28 -
broadly consistent with this trend. It can be concluded therefore that the
setting of a formal lending target for the transport sector had little effect
on this down-trend.
Loans for housebuilding, by Sonali and Agrani banks, rose fairly
rapidly from 0.13% of advances in December 1976 to 0.93 of advances in
December 1978 (Table 9). This rising trend was maintained by the Agrani Bank
during the next year, while that of Sonali Bank was reversed leading to a
i small overall decline. Clearly the increase is not solely due to targeting
policy, as the removal in 1975-76 of restrictions on lending to this sector,
would have led to some re-allocation towards it.
The earlier analysis of loan rate ceilings also suggests that
differentially lower ceilings on rural housing loans (-1%) and multistoreyed
housing (-6%) might have been responsible for breaking the uptrend in housing
loans. However rural housing loans were an insignificant part of the
institutional loans for housing, before the special scheme was introduced in
1977-78. Similarly multistoreyed housing is a relatively new phenomenon in
the housing market and would not have had an immediate impact on total housing
credit. This is consistent with the different effect on the three banks.
I have shown elsewhere [Virmani (1982)] that there are certain problems
of information flows and interpretation which can lead to inefficiency in the
form of exclusion of certain types of borrowers and certain types of economic
activity. The analysis suggests that there may be a discrepancy between the
social and private returns to loans which requires a short term subsidy to the
banks. It is also suggested there that the subsidy will (probably) have to be
linked with a requirement to lend to the identified borrower categories. Any
element of forced lending, must however be only for a short introductory
period. This induces banks to collect information and generate links with the
- 29 -
neglected sector, a kind of forced learning by doing. A policy of
targeting/guidelines when accompanied by appropriate incentives can therefore
be justified for short periods for new and unfamiliar activities. Thus the
initial success in increasing the share of house building loans may have been
partly due to the guideline targeting approach.
This analysis is also supported by the differential performance of
banks in terms of loan share of the small loan category. Thus targeting had
little effect in the case of Sonali bank which already had a proportion of its
advances going to this sector, and already had information links. On the
other hand the Agrani and Janata banks had only .8% and 0% respectively of
their loan portfolio going to the small loan category on December 1975. This
had increased to 3.63% for Agrani by December 1977 and 2.59% for Janata by
December 1978. In both cases it declined after the peak. Three years in one
case and four years in the other was probably more than enough time for the
initial information links and learning to take place. Normal criteria would
eventually begin to apply. Thus the final stable level of lending to this
sector represents a relatively efficient level of lending compared both to the
low initial levels as well as to the peaks reached under pressure.
In 1979-80 banks were asked to raise their credit deposit ratios in
less developed areas, including the Chittagong Hill-Tracks to 75%. It is
highly unlikely that general development problems can be addressed solely or
even primarily by forced lending. Widespread experience, including that of
many banks in Bangladesh, indicates that a package of inputs and programme
(technology, marketing etc.) is necessary. Moreover with the interest changes
in October 1980, interest ceilings for these areas are at 13%, that is 2.5%
below the general rate. This provides a disincentive to bank lending.
Further as the target is linked to deposits from the same areas, if the target
- 30 -
is forcefully imposed, this would also provide a disincentive for raising
deposits from these areas.
A target of 1% of bank deposits for lending for non-traditional
exports was introduced in 1979-80 and continued thereafter. Policies directly
related to export profitability need to be examined very carefully as
suggested in the introduction. If there are also information problems in
export lending, guidelines and targets can be useful for a few years if
accompanied by adequate incentives. However from October 1980 the interest
ceiling for export lending at 12% was 3.5% below the general ceiling.
Informal targets were also set for agricultural lending. However as
target setting was not the major policy tool for agriculture, credit to this
sector will be considered in the section of the primary policy tool used.
3.3 Ceilings and Prohibitions
In the pre-1975 period of high inflation, there were many
restrictions on the use of various types of financial securities, capital
equipment and real estate as collateral. These were gradually lifted. In the
absence of interest rate ceilings such restrictions tend to raise interest
costs to borrowers (see Virmani 1982). Thus credit would be shifted from
those borrowers whose interest rates were previously against the ceiling to
those who were below. The latter would now be paying higher rates but getting
relatively more credit. Inefficiency is increased and credit tends to shift
from unfamiliar, more risky borrowers to familiar less risky borrowes as
perceived by the bank. Such restrictions would also tend to shift credit from
productive to speculative purposes as the latter are less likely to be based
on explicit collateral than on implicit collateral; for example, the margin of
stock value constituting the borrowers equity in a commodity stock. Implicit
collateral (e.g. the value of accounts receivable) can of course be used even
- 31 -
on production loans; but this is done only for a bank's best or prime
customers.
The most widely used ceilings, usually in times of general
inflation, are those on credit to large borrowers, or to all borrowers. Thus
for example in February 1979 banks were exhorted to limit credit to borrowers
and reduce it where possible. Later in the year inventory norms were set and
the banks were told to reduce credit gradually in accordance with these
norms. The objective was to reduce credit to those with high inventories and
large credit. For producers this acts basically as a loan amount ceiling. In
December 1979 formal ceilings were imposed on all borrowers. Industrial
borrowers were limited to 90% of their maximum outstandings in the previous
year. Traders were limited to 85% while export finance, term finance and
special programmes were exempt. In August 1980 the cuts were withdrawn.
Though credit ceilings are usually used for controlling general credit
expansion they have allocational effects which are the primary focus of our
paper. Credit ceiling may also be applied selectively; to mitigate the harsh
effect of general ceilings on particular sectors or borrowers. To this extent
they can be seen directly as an allocational instrument. I have shown
elsewhere (Virmani, 1982) that ceilings on loan amounts to producers, when
effective, reduce the cost of loans to the borrower, through a lowering of
interest rates. Further they are likely to be more effective against the
larger, more organised better placed borrowers, mainly because they are easier
for a government to police. Thus they are likely to have perverse welfare
effects within the set of borrowers. When applied to all existing borrowers
they are likely to channel loans away from current borrowers to new less
productive borrowers. When applied to a subset of borrowers they will tend to
shift credit to those not subject to these restrictions, while lowering
- 32 -
interest rates to the former. But a better way of rechanelling without
adverse distributional effects is to put an interest tax on lending to non-
favored borrowers. Overall efficiency in use of credit will deteriorate under
both policies, unless all favored creditors were previously getting less than
the efficient amount of credit. This is unlikely to be true.
Loan ceilings on credit which is going into stocking for speculative
purposes has somewhat different effects. In this case it can be shown that an
effective ceiling on loan amounts per borrower will increase the interest rate
on loans. However if these rates cannot be raised because of interest rate
ceilings then no loans will be made to the potential borrowers. Loan ceilings
can therefore be useful in this case if they are effective.
3.4 Margin Reguirements: Overview and Analysis
In Bangladesh, as in many other countries, government setting of
minimum margin requirements have been used primarily as an instrument for
controlling "speculation and hoarding", in specific commodities. Thus they
were in most active use when prices of particular commodities considered to
have large adverse social consequences started to rise very rapidly. Among
the specific commodities have been rice and paddy, sugar, oil and oil seeds,
jute and jute goods, onions and chillies, salt, cotton yarn and textiles, and
synthetic yarn and textiles.
As shown in Table 10, at the start of the period under consideration
the margin requirement on Jute and Jute goods was implicitly 100% as all
lending for this purpose was banned. This was motivated by the high rates of
growth of prices, which rose by 63% in 1974-75. As price growth eased to 4.4%
in 1975-76, credit was allowed to this sector. However a sharp rise of 40% in
the prices of these goods in 1977-78 following on the heels of a rise of 11%
the previous year does not seem to have led to an increase in margin
Table 10: Rate of Growth of Prices and Imposition of Margin Requirements (In percentages)
1974-75 1975-76 1976-77 1977-78 1978-79 1979-80
1. Jute and Jute GoodsMargin 100. 0(?)Rate of price growth 63.00 4.37 11.32 39.99 1.18
2. SaltMargin 50 0 b/Price growth 751.0 -66.84 20.47-' 5.8&- -17.9
3. Sugar (Alloted by food Dept)t¶argin 0(?) 50Rate of growth of crude prices 0 -21.10 1.60 12.00
4. Oil & Oil Seeds (Oil Mills-Margins)Local 0(?) 50Imported 25 0Finished Product 100(?) 50
Mustard Oil Prices (Rate of Growth) -32.18 -15.00 35.20 -0.20
5. Cotton, Yarn & Textiles and 50 0 50Synthetic Yarn & TextilesRates of Growth in;Sari Prices -0.47 -1.45 10.65 26.49 2.81WPI for Manufactures 49.73 -43.07 -2.63 5.97 7.41
6. General Merchandise TradeMargins 0(?) 50 60
Rate of Growth ofCOL Index for Middle Income Groups 67.17 -8.40 2.40 12.60 8.30 18.50COL Index for Non-Food 52.10 11.40 4.40 9.50 9.30 14.60COL Index for Food -16.00 1.05 15.64 6.80 20.96
a/ There were informal guidelines in margins during this period.b/ Informal norms were prescribed to banks.
Sources: Resume of Financial Institutions, Finance Ministry, Various Issues.Bangladesh Bank, Annual Reports.Statistical Absgract of the Bangladesh (-ov,rnmnt.
- 34 -
requirements. Thus the use of this instrument seems to decline over time,
perhaps corresponding to a decline in concern over hoarding. Similarly the
margin requirement of 50% on advances against salt was accompanied in 1974-75
by rate of growth of 751% in salt prices. These margin requirements were
eliminated the next year as prices fell by 66.8%. Guidelines were issued in
1976-77 as prices again rose by 20.5% and inventory-credit norms were
established the following year. The sharp decline of 18% in salt price in
1978-79 led to some positive credit measures. Lending, for sugar alloted by
the food department, could be done at 50% margin in 1977-78. As sugar prices
were controlled throughout the period, the best available (though imperfect)
measure of tightness or rationing in the sugar market was gur prices
(jaggery). Thus gur prices, after falling by 21.1% in 1976-77 increased by
1.6% in 1977-78 suggesting a corresponding increase in demand pressure
relative to supply in the sugar market. This is confirmed by the still higher
price rise of 12% in gur prices in 1978-79.
Credit margins on borrowing by oil mills against local oil seeds and
oils were put at 50% in 1977-78. Similarly a 25% margin requirement was
specified on imported oils and oil seed during the same year. Prices of
mustard oil, which constitutes the most important local oil, provide the
answer. Price declines of 32% and 15% in 1975-76 and 1976-77 were followed by
a price rise of 35% causing alarm to the government. A decline of 0.2% in
mustard oil prices in 1978-79 led to a removal of margin requirements on
imported oils and seeds and a fall in margin requirement to 50% on finished
products of oil mills.
Margin requirements seem to have been directed primarily against
agricultural commodities, and within that primarily on goods of common
consumption. Thus, for example, lending to private rice and paddy traders has
- 35 -
been banned for most of this period, giving an effective margin requirement of
100%. The other major good in the consumption basket is clothing. As we
might expect both cotton yarn and textiles and synthetic yarn and textiles
have been subject to margin requirements (Table 10). The early period also
witnessed wider use of margin requirements on industrial inputs suggesting use
of margin requirement as a more general credit control and inflation fighting
device. As recently as 1978-79 margin requirements on general merchandise
trade were raised from 50% to 60%, following observation of accelerating
inflation in 1977-78 and 1978-79 (Table 10).
Before determining the effects of this policy instrument in
different contexts, it is useful Ito analyse the effect of margin requirements
in a simplified context. Consider a situation in which credit is being used
purely for speculative purposes, that is to buy and hold commodity stocks in
anticipation of a price rise. Consider a bank and a speculator who are
neutral in their attitude to risk and are therefore interested only in the
expected returns. To begin with we assume that the speculator has a fixed
amount of outside funds or equity available to him for purchase of
commodities. Given this equity, we can define a loan supply curve for each
borrower-lender pair which is limited at one end by the condition that banks'
have positive expected profits. The speculator's demand curve is perfectly
elastic; if at any interest rate it is profitable for him to borrow it will be
profitable to borrow an infinite amount. Thus a 'rationing equilibrium' can
emerge as shown below (r*, L*), if banks act competitively. In such a
situation, if government imposes a margin requirement m (m > e which ise + L* e wi is
effective, it is equivalent to a loan ceiling
- 36 -
Figure 1
LS
L~~~~~~~~~~LE ~ ~~~~ X
, .~~~~~~~~~~~~~~~~~~~~.
1~~ e
L = e (--1) (from m = e+ L , e is the value of the stock). As shown in the
ceilings exist, and the new interest required is higher than these ceilings no
loans will be made.
Even when the effect of government imposed margin requirements falls
on loans for productive purposes, it still acts as a loan ceiling. The effect
of loan ceilings has been shown above (section 12). When commodity stocks are
used as collateral by producers, the ratio of the loan value to the collateral
is of course referred to by banks as the 'margin'. This ratio, or bank set
,margin requirement' will, in general, be different for different producers,
even for the same collateral commodity. This is because the returns from and
riskiness of the productive activity in which the loan is used varies across
borrowers. All the terms of the loan contract will therefore differ: more
productive borrowers will obtain better terms than less productive ones. This
will tend to result in lower effective margins for the former than for the
latter.
Returning to the case of speculator borrowing, the speculator's
equity contribution may not be fixed as assumed. If, instead, the speculator
has a rising marginal cost of equity funds, similar results are obtained. The
- 37 -
only difference is that an effective margin requirement raises the marginal
return to speculator equity and therefore brings forth additional equity funds
into speculation. As a result interest rates do not rise as much as in the
fixed equity case, and the number of eliminated borrowers will be smaller.
Thus effective margin requirements can reduce the flow of funds for
speculative purposes and raise the cost to current borrowers.
3.5 Margin Requirements: Differential Impact
In Table 11 and 12 we present data on the distribution of credit by
margin requirements for some of the commodities reviewed above for which data
is available for the relevant time periods. These statistics relate to
Nationalised Commercial banks (NCBs). The results for sugar, and oil and oil
seeds are broadly consistent with the above analysis. Thus for sugar the
imposition of a 50% margin requirement in April 1978 resulted in a substantial
change: Between June 1977 and June 1978, the proportion of credit with no
margin requirements, went from 84% to 53%, while that with 50% margin
requirement went from 5% to 28%. This was accompanied by an increase in
proportion of credit subject to 25% margin. As this credit includes credit
going to public sector sugar mills, this represents a fairly effective
shift. This shift in the allocation of credit by margins was accompanied by a
fall in loan size per borrower from TK 6280 to TK 1040. Total loans against
sugar also declined from TK 408 thousand to TK 281 thousand. Both these are
consistent with our analysis.
By June 1979 however virt:ually no loans were at 50% margin, with
about 90% of the loans being at margins of 25% or less. The average loan size
had increased back to TK 5820, evert though total loans against sugar were
still at a reduced level of TK 245 thousand.
- 38 -
Table 11: Distribution of Advances by MarpinR for Specified Securities, and Average Loan Sizeby tlrgl, for saae Seeurities
1. 01 Seeds - Proportion 30-6-76 30-6-77 30-6-78 30-9-78 3-6-79 30-9-80
Percent of Advances
ex 88.00S 35.98S 4.512 17.73X 10.32S202 4.54 8.03 11.05 7.00251 33.76 9.94 12.81 6.6830S 15.53 11.224O250S 3.45 2.65 70.63 63.00 75.23 75.13> 502 .52 .79 .0 4.68 11.19
Total (All margins) 100.00 io0.0o 100.00
Average Loan Size (in 1000 TK) *
OS 66.01 (11) 14.13 .91 (18) .76 1.92202 1.51 (25) 1.44 11.25 2.55
25Z (17) (39) 3.73 3.37 (2) 11.28 3.72302 1.86 (3) 6.59402502 (9) .94 (10) 1.14 (49) 2.93 (64) 2.63) (67) 1.64> 502 (1) 1.56 (1) 3.43 0 (54) 2.06 (5) 2.09) (15) 1.09
Total (All margins) (89) 8.81 (125) 3.45 (102) 2.00 (241) .73 (88) 2.54 (100) 1.46
Total Aeount 299.80 431.92 203.49 223.74 146.09
2. 2D111E OIL
Percent of Advances
0 95.35% 36.412 21.782 38.612 43.782
10 87.56S152025 4.04 52.16230 61.34X4050 57.18> 50 (99.99S) 0 0 52.69S
Average loan size (in 1000 TV)*
0 (4) 119.48 (4) 49.82 (5) 2.75 (4) 31.94 (4) 203.4610 (1) 104.122025 (6) 3.37 (4) 43.1530 (5) 67.144050> 50 (99.992) (1) .67 (1) .67 (2) 18.07 (14) 69.96
Total (All mArgins) (14) 35.80 (18) 30.40 (46) 1.37 (38) 3.13 (15) 22 .06 (28) 66.38Total Advances 501.23 547.26 63.20 118.91 330.93 185.82
3. Sugar 4 GUR
Percent of Advances
0 84.332 84.41S 53.04X 56.962 48.842
10 16.9325 9.842 10.312 18.60S 22.12 24.0430so 4.74 27.72 14.15
Averae Loan Size (in TKI 1000)*
0 (20) 21.94 (50) 6.89 (236) .63 (13) 10.65 (14) 8.5310 (3) 13.8025 (5) 10.24 (3) 13.02 ".) 52.22 (1) 53.80 (1) 58.783050 (10) 1.93 (30) 2.59 (20) 1.72
> 50 (1) .99
Total (39) 13.34 (65) 6.28 (270) 1.04 (44) 5.53 (42) 5.82520.38 408.04 280.70 243.19 244.60
* Numbers In brackets are the total nuuber of borrowers taking nans at specifted margins.
Source: Scheduled Bank Statistics, variouR lisues. NCR: Nationslited Consercial banks.
- 39 -
The 50% margin requiremLent on oil and oil seeds was imposed in April
1978. In the case of oil seeds, the proportion of advances with this margin
increased from 3% in June L977 to 71% in June 1978; for oils the proportions
went from virtually 0 to 57% over the same period. Total loans advanced
against oil seed and oils fell from TK 432 thousand to TK 203 thousand and
from TK 547 thousand to TK 63 thousand respectively. Average loan size
similarly fell from TK 3450 to TK 2000 for oil seeds and from TK 30 thousand
to TK 1 thousand for oils.
The margin requirement on finished products was reduced to 50% in
July 1978 while that on imported oils and oil seeds was eliminated in August
1978. As imports consist largely of oils, both these would affect the loans
advanced against oil. By June 1979 the proportion of advances at 50% margin
was virtually zero, while total loans had increased to TK 119 thousand and
loan size per borrower to TK 3 thousand. In contrast, by June 1979 the
proportion of advances against oiLseeds subject to 50% or higher margin had
increased from 10% to 80%. This wias accompanied by a marginal increase in
total amount loaned and loan amount per borrower. Again these results support
the analysis.
The common feature of these two cases is that both were agricultural
consumer goods considered to be of socio-political importance. As far as
urban markets are concerned production trade and consumption are quite clearly
separated. Both goods are not very important as intermediate inputs.
Therefore, it is relatively easy t:o distinguish between stock holding for
speculative from that for productive purpose. In addition, in both cases
margin requirements were imposed at the start of a sharp upswing in prices.
These features contrast with the case of textile goods.
- 40 -
Table 12: Distribution of Advances by Rates of Margin for Related Securities
Nationalizred commercial Banks
(Percent of advances for all margins)
1. Cotton Textiles, Yarn - Export 30-6-76 30-6-77 30-7-78 30-6-79
0 5.87% 6.43% 5.622 *10/15 2.6220 50.35 18.35% 23.24 12.1325 35.54 41.15 38.17 40.2230 3.19 30.02 9.3635/4050 2.31 19.80 28.3375
Total Advanices (in 1000 TK) 2427.77 587.01 986.82 931.70Average Loan size* (1432) 1.69 (172) 3.41 (946) 1.04 (358) 2.60
2. Cotton Textiles - Irmport
0 1.07% 53.92% 41.77 75.85%10/1520 3.65Z 1.87 4.41 9.1125 83.52% 38.18 44.33 3.273040 7.96% 1.47 3.2050 3.13 4.20 7.78
Total Advances (in 1000 Taka) 2394.02 7205.20 6584.11 3746.16Average Loan size (174) 13.76 (323) 22.30 (236) 27.90 (429) 8.92
3. Cotton & Synthetic Yarn - Imp.
0 19.97% 55.66% 71.47% 51.43Z5-15 13.56 7.8920 5.572. j 5.69 7.83 9.6630 27.42% 10.94X 17.64%40 24.571 2.37 3.3550 12.82% 5.98 8.68 3.3475 5.82
Total Advances (in 1000 Taka) 424.91 1321.68 2617.09 2078.27Average Loan size (191) 2.22 (342) 3.86 (358) 7.31 (374) 5.56
4. other Textiles
0 55.20% 2.47% 16.92% 27.00%15 18.67% 17.85 15.7622 5.58 14.2425 32.86% 38.52 26.05 33.53;1, 3.07 5.77 16.0650 4.252 4.58 . 10.37
Total Advances (in 1000 TK) 381.51 246.83 466.33 419.33Average Loan slze (62) 6.15 (83) 2.97 (170) 2.74 (126) 3.33
30-6-75 30-6-76 30-6-77 30-6-78 30-6-79 30-6-80
5. Merchandise
No. of Accounts 9377 11030 57774 143437 112005 153609Amount (in 1000 'TY) 46999.00 54422.00 622S4.00 78112.00 111896.00 160603.00Average Loan Size 5.01 4.93 1.08 .54 1.00 1.05
Average Loan Size (in 1000 Taka)1. Export Conmoditles 10.78 4.93 1.07 1.82 2.48 2.49
(Jute, Cotton, lextileS4 Yarn, etc.)
iI. Import Commodities 2.77 3.89 3.19 3.24 3.30 3.55iiI. Other Import Herchandise 3.06 2.91 .27 .11 .27 .34
(wheat, rice, oilseeds, oll,sugar, olives)
* No. of borrowersSource: Scheduled Bank Statistics, Various Issues.
- 41 -
Table 13: Distribution of Advances by Rates of Margin: All Advances of NCBs
(In percent)
30-6-78 30-6-77 30-6-78 30-9-78 30-6-79 30-6-80
Margin
50% .2.19% 3.21% 6.30% 6.54% 6.18% 4.98%
60% .07 .07% .05% .51 1.40 1.38
99.99% .24 1.55% .98% .28 .28 0.37
Total Volume
(in 1000 Taka) 69239.15 88351.33 115516.37 131177.94 142627.00 210419.38
Average Loan Size (in 1000 Taka)
50% .22 .L8 .16 .16 17.23 .16
60% .06 .04 .02 .20 .29.20 .26
99.99% .10 .69 .14 .05 .03 .05
Total .66 44.87 .15 .16 16.30 .14
NCBs: Nationalized Commercial Barnks.
Source: Scheduled Bank Statistics, Bangladesh Bank.
- 42 -
In September 1975 margin requirements on cotton and synthetic goods
(yarn and textiles), was reduced from 50% to 0%. In June of 1976 therefore
there were virtually no advances against cotton textiles and yarn (export
commodities/Category 1) and cotton textiles (import commodities/Category 2)
carrying a margin of 50% or higher. Approximately 86% of advances under each
category had margins of 20 or 25%. In the use of cotton and synthetic yarn
(import commodities/Category 3), 12.8% of advances were at 50% margin with
substantial percentages having margins of 0, 30 and 40%. Similarly other
textiles (Category 4) had 87% of advances with margins between 0 and 25%, and
4% of advances at 50% margin.
The imposition of a 50% margin requirement on cotton and synthetic
goods (yarn and textiles) in March 1977 had a gradual effect on margins
applicable to cotton textiles and yarn (export). Proportion of advances
carrying a 50% margin increased to 2.3% in June 1977 and 19.8% in June 1978.
However the initial fall in total advances from TK 2428 thousand to TK 587
thousand was reversed by June 1978. The immediate effect on average loan size
was to double it from TK 1.7 to TK 3.4 thousand. This fell back to TK 1.0
thousand by June 1978. In the other three textile categories there were very
little or no effect on proportion of advances having margins of 50% or
higher. Thus the proportion of advances having a margin requirement of 50% in
June 1976, 1977 and 1978 for category 2 were 0%, 3.1% and 4.2% respectively;
for category 3 were 12-8%, 6-0% and 8-7% respectively, and for category 4 were
4.3%, 4.6% and 0% respectively. Similarly total advances and average loan
size decreased for category 4 and increased for categories 2 and 3 between
June 1976 and June 1977.
Part of the reason for these contradictory effects are, the plethora
of special policies applicable to imports and exports and the freedom to
- 43 -
import under the Wage Earners' Schieme since April 1977. The major reason is,
however, the difficulty in separating use for consumption from use as an
intermediate input, and the holding of stocks for speculation from holding of
stocks for production. Thus, borrowing at 0% margin went up between June 1976
and 1977, from 1% to 54% for category 2 and from 20% to 56% to category 3.
These were the two categories of goods for which perverse effects were
strongest. This suggests borrowing by textile production units, and among
them the public sector textile corporations which are major borrowers. Thus
the imposition of margin requirements was largely ineffective as credit was
diverted from existing trader-borrowers, to new borrowers and to producers.
Over a longer time period, new traders can also enter the business if entry
(information) conditions are not too difficult. This would further reduce the
effectiveness of the policy.
General margin requirements on merchandise were increased to 50% in
August 1977. The effects of this are shown in Tables 13, 14 and 15. The
proportion of all NCB advances having a margin requirement of 50% doubled from
3.2% to 6.3% between June 1977 and June 1978 (Table 13). The increase of 3%
points appears small; but the margin requirement was increased only on
merchandise and not on other securities. The former constitute approximately
65% of total loans (Table 14). By making a simple adjustment we can say that
the re-chanelling was approximately 4.8% (instead of 3%) within the advances
which had merchandise as security. Over the same period, the proportion of
all loans by NCBs going to trade declined from 35% to 28% (Table 15). This is
consistent with our analysis. A similar conclusion emerges for all banks if
we look at the proportion of loans going into trade credit (Table 1).
Margin requirements on mtsrchandise were increased further to 60% in
July 1978. As a result, by June 1979 the proportion of advances with 60%
Table 14: Distribution of Advances by Securities
Nationalized Commercial Banks
FY 75 FY 76 FY 77 FY 78 FY 79 FY 80
A. Gold and Precious Metals .7 .9 1.2 1.2 1.2 1.0
B. Securities 1.3 1.2 1.1 1.4 1.4 1.0
C. Merchandise 74.0 72.6 65.0 62.0 64.2 68.3
(i) Raw Jute 21.9 15.4 6.5 6.1 12.6 11.6
(ii) Jute Manufacture 14.8 11.5 11.3 14.1 11.8 7.8
(iii) Other Export Commodities 6.2 6.4 8.2 7.5 6.4 14.4
(iv) Imports 31.11 39.3 38.9 34.3 33.3 34.4
D. Machinery and Fixed Assets 2.0 2.4 2.1 2.0 2.6 2.1
E. Real Estate 2.6 2.3 2.7 2.9 3.2 2.9
F. Financial Assets 1.9 2.2 3.1 2.4 2.3 1.6
G Miscellaneous 17.5 18.5 24.8 28.1 25.2 23.5
(i) Secured 11.4 12.3 17.6 16.5 19.0 16.9
(ii) Unsecured 6.1 6.1 7.3 11.6 6.47 6.6
Source: Scheduled Bank Statistics, Bangladesh Bank.
- 45 -
margin increased to 1.4% from .05% in the previous year; an increase of only
1.35% points (Table 13). The proportion of advances going to the trade sector
increased to 32% (from 28%, Table 15), along with the use of merchandise as a
security (Table 16). The following year the advances having a margin of 50%
or over declined to 6.7% of total advances from 7.9% the previous year (Table
13). Thus the results were quite mixed; any effects of the increased margin
requirements appear to be quite transitory when applied on such a broad
scale. The reason is that both borrowers and equity funds can move much more
easily between production and trade, and between different types of
securities. Even if immediate movement is precluded, given time such movement
seems almost inevitable.
Thus the use of margin requirements appears most effective for
agricu'ltural consumer goods for wlhich short run price movements have adverse
socio-political effects. But even in this case the policy may not be
effective for very long, as the possibility of speculative stock holding
within the agricultural sector would increase over time. This could also lead
to a diversion of agricultural credit from productive to speculative usage.
In fact one of the banks gave us an example of diversion of credit from
agricultural production to stockinig of chillies in anticipation of a price
rise.
Table 15: Distribution of Advances by Economic Purposes '
Nationalized Commercial Banks
FY 75 FY 76 FY 77 FY 78 FY 79 FY 80
Agriculture, Hunting, Forestry and Fishing 2.2 3.86 4.5 7.98 10.6 11.5
Mining and Quarrying 0.1 .1 1.4 .77 .1 1.5
Manufacturing 50.4 43.42 39.2 40.2 39.2 39.4
Construction 1.0 .9 1.5 1.7 1.7 1.6
Electricity, Gas and Water .1 .1 .1 .32 .7 .5
Wholesale Trade 30.4 36.2 35.0 28.2 32.2 31.4
Finance.and Real Estate 4.1 2.6 2.8 2.6 3.2 2.9
Transport, Storage and Communication 6.1 7.1 6.8 5.7 4.9 4.2
Others 5.5 5.7 8.8 12.6 7.5 6.8
Source: Scheduled Bank Statistics, Bangladesh Bank
- 47 -
3.6 Refinance and Counter Finance: Overview
Central Bank (Bangladeslh Bank) loans to scheduled banks go under
several names, including refinance, counterfinance and back-to-back finance.
The percentage of refinance has varied between 30% and 100%. One way of
organizing these different programs is to separate the ones which have 100%
counterfinance or back-to-back finance from those which have less. In the
first case the bank is acting puretly as an intermediary between the central
bank and the final borrowers. In the second case a proportion of the lending
must be financed out of deposits and therefore the allocation of deposits
between refinanced and non-refinanced lending becomes relevant.
An alternative way of looking at it, which is more fruitful in the
present case is in terms of specialised banks which direct lending to specific
sectors or sub sectors, and commercial banks. For the purpose of the
refinance issue, the agriculture oriented banks - BKB and BSBL - are of
relevance to the first category. All agricultural sector lending of these two
banks has been refinanced at 100% by the Bangladesh banks (though very
recently the proportion has been reduced to 95% for BSBL). The refinance rate
has been 6% since 1974. It has thus been subsidized to the extent of 2%
points (below the regular discount rate of the Bangladesh bank) between June
1974 and October 1980 and by 4.5% since the discount rate was raised to 8.5%
in 1980.
Table 16 shows the sanctions and disbursement of loans from the
Bangladesh bank to the agricultural banks (BKB and BSBL). The amounts that
these banks are entitled to have refinanced is calculated at 100% of their
disbursements. Disbursements as a proportion of sanctions fluctuated
considerably over the period but showed a rising trend; going from 78% in
1975-76 to 100% in 1979-80. However in 1979-80 disbursements exceeded
Table 16: Use of Refinance by Bangladesh Krishi Bank (BKB) and Bangladesh Samabya Bank (BSBL)
Bangladesh Bank Loans to BKB & BSBL 1974-75 1975-76 1976-77 1977-78 1978-79 1979-80 1980-81
1. Sanctioned 2489 3300 4616 8885 8734 12970 15859
2. Disbursed 2075 2589 3922 6347 8617 13015 16739
3. Cumulative Disbursement (from 1974-75) 4664 8586 14933 23550 36565 53304
4. Cumulative Sanctions (from 1974-75) 5789 10405 19290 28024 40994 56889
Agricultural Banks (BKB & BSBL)
5. Entitled Borrowing /1 2605 2768 4301 5434 8189 14600. 21102(at 100 of disbursement)
6. Cumulative Entitlement 5373 9674 15108 23297 37897 58999
7. Disbursed/Sanctioned (Row 2 - 1) .83 .78 .85 .71 .99 1.00 1.06
8. Disbursed/Entitled (Row 2 5) .80 .94 .91 1.17 1.05 .89 .79
9. Cumulative Disbursement/Cumulative entitlement (Row 3 *- 6) .87 .89 .91 1.01 .96 .90
10. Average of Rows 7 and 8 .815 .86 .88 .945 1.02 .945 .925
11. Cumulative Disbursement/Cumulative Sanctions(Row 3 * 4) (.83) .80 .83 .77 .84 .89 .95
1/ It is not entirely clear from the data whether disbursements are for agricultural credit alone or alsoinclude trade, storage marketing of agricultural goods.
Source: Bangladesh Bank, Annual Reports
- 49 -
sanctions for the first time and in 1980-81 this reversal become more
pronounced. This peculiar situation arises because of delay in disbursement
of loans committed in the previous year.
The proportion of refinancing actually provided can be measured
approximately by the loans disbursed by the Central Bank divided by the
entitlement, as measured by the agricultural banks advances for the year.
These rise to a peak of 117% in 1977-78 and then decline to 79% in 1980-81.
Because of the carry-over of previously committed loans and the partial carry
over of previously sanctioned loans, a better (but still approximate; because
of the abrupt start at 1974-75) measure is the cumulative disbursement divided
by the cumulative entitlement. This shows refinance proportion rising from
87% in 1975-76 to 101% in 1977-78, suggesting that most backlogs were cleared
by this time. Refinance remained aLt the fairly high level of 96% in 1979-80
but fell sharply to 90% in 1980-81. This suggests that even though actual
refinancing by the Bangladesh bank may have fallen below 100%, due to the
application of constraints ona general credit expansion, the goal remained at
100%. In contrast, in 1979-80 and 1980-81 loan sanctions are actually below
loan entitlements for the first time, suggesting an implicit movement away
from the goal of 100% refinancing of agricultural banks.
The commercial banks, and the BKB for its non-agricultural lending,
are entitled to refinance on a wide variety of items. The current rates of
refinance are as follows:
Food and Fertilizers (BADC), Petroleum and Petroleum Corp. 100
Exports Non-Traditional 100%
Traditional 50%
Small Loans 0% (100% until late )Sugar 50%
Jute 50%
SACP 50%
- 50 -
The refinance rate for the special agricultural programe (SACP),
like the agricultural lending of BRB and BSBL, carried a 2% subsidy on the
Bangladesh bank rate. All other sectors got refinace at the discount rate
which was 8% between June 1974 and October 1980 and 10.5% thereafter (Table
4).
The total amount of refinance taken under these catagories rose
steadily from 251.53 lakhs in 1979 to 703.88 lakhs in December , a growth of
180%. The annual compound growth rate from June 1979 to June was 67% a year,
representing a fairly substantial increase in refinance. Jute was the largest
user of refinance throughout the period, but grew by only 23.5% from 119 lakhs
in June 1979 to 146.98 lakhs in December . Refinance to the petroleum
corporation started in December 1979 and has been the second largest since
December 1980. Food and fertilizer have changed places for the next position.
Given the diverse items for which refinance is provided it is useful
to look at some of the explicit and implicit objectives. Both food and jute
are subject to annual fluctuations in production. Refinance is seen as a
means of providing credit for holding stocks in a deflationary situation. Our
earlier analysis of speculative credit suggests that commercial banks would
tend to provide little credit in this situation. But this question really
needs to be looked at in terms of the buffer stocking policy of the
government. Macroeconomic issues are also important. A properly worked out
buffer stocking policy would trade off sectoral effects and macro economic
effects, and work out a self supporting buffer-stock policy. Any desired
subsidies, should in general go direct to the producer and not to private
traders.
Sugar production has a strong seasonal pattern. Both lender banks
and potential borrowers know that prices will fluctuate in a seasonal pattern
- 51 -
over the year. The analysis of speculative credit does not indicate that
banks will not provide credit in this situation. However a seasonal buffer
stocking policy which is self-supporting could be worked out if necessary. If
it is thought necessary to provide subsidies to producers or consumers these
could be provided directly.
Provision of refinance to the petroleum corporation is used
essentially to fill the gap between the rise in oil prices and the rise of
final product prices. Thus it can be seen as a means of providing a
consumption subsidy to oil consumers. Even if such a subsidy is to be given
there does not appear to be significant reasons for using the banking system
for this purpose. The provision of refinance to BADC for fertilizer has a
completely different purpose. Subsidies are provided explicitly through the
budget: Delays in receipt of the subsidy or short term liquidity problems are
however met by providing 100% refinance to banks for their lending to BADC.
This appears to be a more satisfactory method for achieving a similar purpose.
In the case of non-traditional exports information problems can
effect the flow of credit, as I have shown elsewhere (Virmani 1982). A
determination must be made, however, whether this is the primary, or even a
major problem. This requires a prior examination of the foreign exchange
markets and the policies which impinge directly on exports and imports. In
addition one should also look at more general agricultural or industrial
policies which impinge on sectors which are potential exporters. Given
appropriate policies in these areas, credit policies can be used to remove any
inefficiencies in loan markets. These generally relate to new export products
with which bankers are unfamiliar. Credit policies when used for an initial
period can be useful in removing inefficiences.
- 52 -
3.7 Refinance Usage, Incentive Effects and Usefulness
The use of refinance policy as an instrument for redirecting credit
allocation can be examined in the context of the analysis in Virmani (1982). We
start by considering the simplest case of a perfect deposit market, in which a
bank acts as a price taker at a deposit interest rate of i (a more realistic
case is considered below). Let the refinance proportion be h and the
refinance rate p. If the refinance rate is greater than or equal to the
deposit rate, no refinance would be availed of and refinance provides no
incentive. If the refinance rate is less than the deposit rate, the cost of
funds for the refinanced sector becomes i = hp + (1 + h)i which is less than
i the deposit rate. I have shown that the direct effect of this is to
increase loan amounts and reduce interest rates to borrowers. Loans would
also be made for the first time to previously marginal potential borrowers.
Both these would shift credit allocation towards the refinanced sectors.
If interest ceilings exist, the effect of refinancing is to reverse,
partially, the harmful effects of such ceilings. The lowering of the 'free'
interest rate on loans means that on the margin borrowers are shifted from
having an effective credit ceiling to not having one. The effect of refinance
policy on collateral requirements is uncertain, as these may rise or fall. For
those borrowers who are still constrained by the loan interest ceilings, the
adverse distributional consequences of interest ceilings on the poor (little
wealth), may be countered or enhanced by refinance policy.
Table 17 gives the average weighted deposit costs over the period.
The refinance rate for the agricultural banks has been 6% since 1974. (The
refinance rate is of course 8.0/10.5 for the other sectors). This compares
with a interest rate of 3.5 to 4.3% till 1980 and 7.0% in respectively.
Under such a situation our analysis suggests that these banks would not have
Table 17: Average (weighted) Deposit Rate
FY74 FY75 FY76 FY77 FY78 FY79 FY80 FY81
A. Weighted AverageDeposit Rate 3.0 3.5 4.2 4.3 4.2 4.3 4.3 7.0
B. Deposit Cost Adjusted forReserve Requirements
i- - i - 2.3 1.3 2.4 2.5 3.4 2.5 3.4 3.4 7.03
Co A -B 1.7 1.1 1.7 0.9 1.7 0.9 0.9 0
Ln
JI
- 54 -
taken any refinance, at least till October 1980. Because of the existence of
reserve requirements, however, we might expect that the effective cost of
funds is higher than the average interest rate. It is easily shown that the
effective rate i is as follow
i - bai baii g = - - g
1-a 1-a 1-a
where a is the total reserve requirement, b is the proportion of reserves
required to be put in government or other securities earning a rate rg . It
is assumed that a proportion (1-b) of reserves is held as cash which earns no
nominal interest rate. For Bangladesh a = 0.25, ab = 0.2 and
it = 8.5% (rate on ad hoc treasury bills). Using these amounts we
find that the adjusted cost of funds is less than the unadjusted (table 17).
This happens because deposits can costlessly earn a net return of (8.5 -
i)%. On the other hand we have not adjusted for the transaction cost of
dealing in government securities, or for the administrative cost of servicing
depositors. The first would reduce the negative adjustment in the above
formula. The second means, that the effective cost of deposits is i + t and
that adjustment raises both the effective interest cost and the effective
administrative cost. A rough calculation suggests an administrative cost of
1.3 to 2% of deposits. Use of these would reduce the gap between the adjusted
and unadjusted (effective) cost by 0.5%-0.7%, still leaving the former less
than the latter. If we take the unadjusted values as an upper limit, there
would have been no refinance taken under this situation till October 1980.
This contrasts sharply with what actually happened.
Clearly the perfect deposit market approximation is not useful for
current purposes. The more appropriate assumption is to assume that deposit
- 55 -
rates are fixed by the government: and total deposits available are therefore
fixed exogenously or given. We also make the approximation that the deposits
with each bank are also not subject to their control in any way. In this case
it is easily shown that banks will earn rates equal to s - i (positive) times
their deposits, where s is the opportunity cost of funds (a shadow-price).
The loan decisions of the bank, and the effects of various policies, can
effectively be analyzed by using s instead of i. Consider the question of
refinance. In this case refinance policy can be effective as long as the
refinance rate p is less than the opportunity cost s. The effective cost of
funds for the refinanced sectors is therefore p hp + (l-h)s which is less
than s. As an aside it should be noted that as the agricultural banks were
getting refinace at 6% their opportunity cost of funds (s) must be higher than
this.
The allocative effect is virtually the same here as in the previous
case both with and without interest ceilings. To restate, there would be a
shift in credit allocation towards; the refinanced sector, and the full amount
of entitled refinance would be used. The experience of the agricultural banks
is broadly consistent with this analysis. As shown in the beginning of this
section (and Table 16) the banks were taking virtually 100% of this refinance
entitlement till 1979-80. In Table 1, and the accompanying discussion it was
shown that the allocaton of credit has increased progressively from 11% of
total credit to 30.6.75 to 19% in 30.6.80. It was also shown that the index
for output adjusted credit to agriculture similarly doubled from .17 to .34
over the same periods. The contrast between the performance of the
agricultural banks and the commercial banks (to be analyzed subsequently)
suggests that refinance policy combined with the existence of specialized
agricultural banks was an important causative factor.
- 56 -
Table 18 gives the usage of refinance by the scheduled banks
(including limited usage by BKB for non-agricultural purposes) by purpose and
by bank. Only for rural credit, small loans and petroleum is there anywhere
near fuil usage of refinance, with a simple average over the period of 96%,
97% and 97% respectively. The lowest usage is in the food sector with an
average of 50%. Usage for all sectors taken together ranges form 69% to 87%
with a simple average of 79%. There is a similar variability in bank wide
usage. This underusage appears inconsistent with the analysis presented
above. The reason for this discrepancy lies in the existence of bank wide
ceilings on total advances.
Consider a situation prior to the introduction of refinance. There
is some division of loanable deposits (total minus required reserves) between
sectors which are to be refinanced and those that are not, say LR and LNR
respectively. When refinance policy is introduced with refinance proportion
h(O < h < 1), hLR of extra funds become available. This is equivalent to an
amount hLR Of the loanable deposits of banks becoming free. In the absence of
credit ceilings, loans to the refinanced sector would rise as alreadyLR
analysed. If they rise to an amount L = (lh) it would mean that all the
excess funds have been used up, and s and LNR would remain unchanged. If
initial Li is less than LR must fall and LNR rise, and vice versaR ~~~(1-h) s
if initial LR is greater than LR/(l-h). In either case, after fullRR
adjustment, there would tend to be an absolute and relative increase in credit
going to the refinanced sector.
- 57 -
Table 18: Refinance: Usage as a Percentage of Entitled Limits:Nationalized Commercial Banks
June 1979 Dec. 1979 June 1980 Dec. 1980 June 1981 Dec. 1981All Banks
Rural Credit 100.00 100.00 98.35 83.07 96.96 96.96Small Loans 99.93 95.40 87.54 100.00 100.00 97.65Export Bills 55.24 88.30 57.56 79.41 86.98 93.27Food 67.70 48.77 74.26 -50.57 39.97 15.88Jute 79.43 97.14 91.17 96.15 81.98 85.92Fertilizer 84.86 79.79 53.66 79.25 75.69 99.69Sugar Mills 100.00 87.48 100.00 35.05 100.00 100.00Petroleum - 100.00 100.00 100.00 94.35 92.37Textiles - - - - 75.91 100.00Other 0 86.98 80.36 74.17 75.60 96.68Total 68.8 86.45 80.61 82.44 75.63 79.92
All Sectors
Sonali 74.7 97.93 96.57 84.81 91.44 82.84Janata 85.1 88.51 76.71 94.00 78.69 85.79Agrani 56.3 69.85 45.75 60.44 15.14 33.82Pubali 50-4 89.02 72.28 49.19 55.71 81.35Ruaalu 74.70 78.00 92.05 84.94 80.11 76.15Uttara 75.10 7Z.36 73.80 85.27 84.19 90.00BKB /_ 36.4 100.00 20.00 - - -
- No refinance related lendingi/ Non-agricultural refinance.Source: Bangladesh Bank
- 58 -
If overall credit ceilings exist, which are totally independent of
the refinance policy, total loans cannot increase. Existing deposits are
enough to finance these loan. This means that any refinance taken goes into
free reserves. If the net return from allowed investment out of free reserves
is lower than the refinance rate, no refinance would be taken. If the net
return is initially greater than the refinance rate full refinance would be
taken. Only if the marginal net return falls with amount invested would
partial refinance be taken.
In the case of NCBs, until October 1980 the refinance rate was 8%,
while ad hoc treasury bills had a rate of return of 8.5%. If an adjustment
for administrative costs were factored in, this would suggest at most a
marginally higher net return on allowed investment. For the refinance rate
at 10.5% is clearly greater than the gross return which remains at 8.5%. The
peak rate of calculated reserves, which generally occur in June due to
seasonal factors, were 26.9% in 1979, 26.6% in 1980 and 27.9% in . Given that
reserves in other months can be significantly lower than these values, and
that the required minimum ratio is 25%, there seem to be no excess reserves
over this period. In the context of the above analysis (credit ceilings
operative), the absence of free reserves is consistent with the low
profitability of allowed investment.
Leaving aside food and export (bills) financing, which is exempted
from credit ceilings, this still leaves open the problem of explaining usage
of refinance at greater than zero rates (Table 18). The explanation lies in
the fact that credit ceilings have not been independent of refinance policy.
Another element which also enters is forced lending. Credit ceilings for a
forthcoming year start from the previous years ceilings. Increases in credit
ceilings, though based primarily on expected increases in deposits and on past
Table 19: Advances and Depo;:its of Scheduled Banks excluding BKB & BSB(In 1000 Taka)
1975 June Dec. 1975 June 1976 Dec. 1976 June 1977 Dec. 1977 June 1978 Dec. 1978 June 1979 Dec. 1979 June 1980 Dec. 19801. Demand and
Time Deposits 93434 194909 107564 128125 133413 156708 160146 194664 211362 244209 248818 .294633
2. Total Credit
Advances & Bills 67927 84883 82136 96548 100544 129965 127568 162434 159775 200739 224316 249290
3. Govt., Foodcredit 443597 195212 1718%6 70339 47341 241127 349689 441905 370256 125757 1290545
4. Credit tMet ofFood 6349103 8293088 8041794 9584461 t 12522559 12515673 15893711 15535595 19703644 22305843 23638455
5. BJMC borrowing (Jute) 1856499 2111395 1677290 1987770 ' 22644883 2440136 3382444 1887549 2508468 1698779 2667808
6. Credit Net ofFood and Jute 4492604 6181693 6364504 7696691 * 10257676 10075537 12511267 13648046 17195176 20607064 20970647
Textile7. Sugar 895278 1661799 1277283 1608189 i 2165125 2123377 2277115 2106665 2932503 4485495 4404240
BADC
8. Net Credit 3597326 4519894 5087221 5988502 8092551 7957160 10234152 11541381 14262673 16121569 16566407
9. Petroleum Corp. 0(?) 933 1758 . 426 4275
10. Net Credit 7781360 11498781 15694069
Credit/Deposit Ratio
It. (a) Total 0.6795 0.7905 0.7476 0.7481 0.7991 0.7815 0.8164 0.7350 0.8068 0.8964 0.8023
12. (b) Minius Foodand BJMCCredit 0.4808 0.5892 0.5917 0.5429 * 0.6546 0.6291 0.6427 0.6457 0.7041 0.8282 0.7176
13. (c) Minus Food,BJMC Credit,Textile Corp.Sugar Corp.BADC 0.3850 0.4308 0.4729 0.4674 * 0.5164 0.4965 0.5257 0.5460 0.5840 0.6479 0.5623
14. (d) Minus (c) sadPetroleum * 0.4859 0.5440 0.6307
* Not avallable.Source; Bangladesh Bank
- 60 -
performance are also influenced by priority sector lending. Small loans and
rural credit are among the more important priority sectors. As already
indicated they are the two sectors with the highest (close to 100%) usage
(Table 18). This means that at least over the period 1979 to 1980 credit
ceilings were sufficiently and consistently adjusted for such lending to make
refinance an operational incentive.
In the case of petroleum and jute goods government has often
virtually forced banks to make loans to meet unexpected situations. In such
cases both refinance and credit ceilings have been wholly or partially
adjusted as an inducement. In the case of sugar mills, BADC (fertilizer) and
food, a similar linking of forced lending, provision of refinance and ceiling
adjustment has evolved as a general long run policy. In effect the last two
are decided by tacit negotiation. In such a situation refinance policy has a
highly erratic incentive effect, and implicit or explicit pressure has to be
applied at various points to maintain or expand lending.
A very approximate measure of the application of this policy package
of forced lending, refinance and credit ceilings can be obtained by getting an
estimate of the non-refinance lending or the proportions of free deposits
available for refinanced sector lending. In Table 19 this is done by
calculating modified credit-deposit ratios; first by subtracting food and jute
credit to the public sector jute mills, and then by further subtracting credit
to BADC and the textile and sugar mills corporation. This final modified
credit-deposit ratio rose from .39 in June 1975 to .56 in December 1980. If
we take the average of June-December figures for 1975 and 1980 the rise was
from .41 to .60, an increase of 46%. This suggests that the deposits
available for refinance related lending declined almost continuously over the
period. Further the total credit-deposit ratio rose from a June-December
- 61 -
average of .74 in 1975 to one of .85 in 1980, a rise of only 15%. Both these
facts suggest an increase in forced lending over the period.
As export bills currently lie outside the credit ceilings, our
analysis suggests that refEinance should be fully used as long as the
opportunity cost of funds (s) is larger than the refinance rate (p). Though
usage has averaged 77% over the period, it has risen from 55% in June 1979 to
93% in December , showing a rising trend. A possible explanation is that
export bills have only recently been exempted from the credit ceilings.
In the absence of a wide market for government securities, provision
of refinance has been an important means of expanding the monetary base. With
deposit interest rates fixed, the opportunity cost of funds (s) is greater
than the deposit interest cost (i). Refinance provides a profit to the banks
as long as the finance rate (p) ls less than s (assuming no excess funds i.e.
no credit ceilings or adjustable ceilings). If the goverment provided general
refinance this would merely transfer seigneurage from the government to the
banks. In this situation, use of refinance as a means of subsidizing credit
to particular sectors where lending is inefficient entails little budgetary
costs, and can be an effective alternative to a policy of interest subsidy to
banks. The two policies differ only in their effect on collateral
requirements. An interest subsidy reduces collateral requirements while
refinance may raise or lower them. Even though a rise in collateral will be
compensated by a greater decrease in the interest rate borrowers with
inadequate collateral will not benefit fully. Thus the poorest might not
benefit from the refinance policy. This effect could be mitigated by
providing a collateral subsidy for loans to the poorest borrowers.
- 62 -
3.8 Guarantee Programs
There are two types of guarantee programs in existence. One can be
termed a liquidity guarantee and the other a loan guarantee. The liquidity
guarantee is applicable to the normal lending programs of the BKB and BSBL.
As already noted these two banks have been getting 100% refinace from the
Bangladesh Bank for their agricultural lending programs. Moreover, this
refinance is only available on their total outstanding loans net of
overdues. In other words the refinance loan is made only on fresh advances.
It has to be repayed in full to the Bangladesh Bank when the loans become due
from final borrowers irrespective of whether they repay their loans to the BKB
and BSBL. The guarantee program allows these two banks to borrow from the
government, up to 30% of the value of the loans disbursed, to cover overdues
and late repayments.
The interesting thing is that BKB has never used this program while
the BSBL has always used it (Table 20). The reason for not using is ofcourse
that it involved a shift from 6% financing to 11% financing, while deposit
costs are much lower than the latter. The other reason is that overdues have
not been a very serious problem for BKB. In contrast, the BSBL does not take
(discussed further in section on agricultural credit).
The loan guarantee is applicable to all banks participating in the
Special Agricultural Program (SACP) often referred to as the TK 100 crore
program. This allows banks to borrow upto 30% of all (SACP) loans
defaulted/overdue on the due date. 30% of all amounts recovered after due
date have to be repayed. Actual payment of loan guarantees under this program
have, however, been less than entitlements, due to budgetary reasons.
Table 20: Payment of Givernment Guarantee to the BanksUnder Special Agrscultural Credit Programme
Name of the 1977-72R iQ77_7R 1978-79 _Bar.ks Guarantee Guarantee Guarantee Guarantee Guarantee Guarantee Guarantee Guarantee Balance remain- Guarantee Guarantee
-_______ claim money Paid claim m R claim money paid claim money paid ing unpaid claim money naid
Sonali Bank 184.90 184.90 184.90 184.90 215.72 215.72 388.58 323.11 65.47 566.21
Janata Bank 140.83 140.83 140.83 140=83 160.95 L60.95 193.35 163.65 29.70 260.85
Agrani Bank 127.07 127.07 127.07 127.07 166.00 66.00 210.40 175.35 . 35.05 97.74
Rtupali Bank 105.87 105.87 105.87 105.87 118.15 !.18.15 131 22 1Q9.36 21 .6 115.45
Pubali Bank 111.42 111.42 111.42 111.42 86.34 .86.34 257.76 215.46 42.30 72.39
Uttara Bank 38.06 38.06 38.06 38.06 23.82 23.82 56.63 47.20 9.43 34.80
Krishi Bank 221.10 221.10 221.10 221.10 210.90 :10.90 601.00 500.87 100.13 241.22
Total 929.25 929.25 929.25 929.25 981.88 981.88 1838.94 1535.00 303.94 1388.66
Source: Bangladesb Bank
- 64 -
In Virmani (1982) I showed that a collateral subsidy (a lump sum or
a proportion of effective collateral available from a borrower) has effects
similar to an interest rate subsidy. Thus it increases loan size and lowers
interest rate and collateral requirements. Therefore if inefficiencies are
present, either due to information problems or due to lack of collateral with
poor producer-borrowers such a subsidy will improve efficiency in a way that
benefits the less wealthy. When banks are risk averse we would expect the
collateral subsidy to be more effective than the interest subsidy, though this
case was not explicitly analyzed.
This analysis can be extended to the loan guarantee as used in
Bangladesh. This essentially involves paying to the bank a fraction of the
under-repayment by the borrowers. In this case too loan size would rise and
loan interest rates fall. However the effect on collateral requirements is
ambiguous, and consequently so is the relative benefit to the less wealthy.
There is however an extra problem in the way in which the Special
Agricultural Program (SACP) is implemented. This is the requirement that no
collateral be taken when giving loans under this program. This restriction
would tend to lower loan amounts an raise interest rates to borrowers. Many
potential borrowers would be excluded. The distributional effects are not
totally clear.
3.9 Urban-Rural Branch Licensing
The Nationalised Commercial Banks (NCBs) were inducted into
agricultural credit by the goverment for the following reasons.
(a) To use the existing deposit base of NCBs to redirect credit
toward agriculture
- 65 -
Table 21: Rural Branch Expansion (No. of Branches)
1974 1975 1976 1977 1978 1979
No. of Branches
INCB's Rural June of Year 648 743 949 1505 1822
Urban 762 833 917 1030 1144
Sonali Rural Dec. of Year 193 222 250 367 439 566Urban 156 178 200 233 270 281
No. of New Branches during past yeat-
NCB's Rural 95 206 556 317Urban 71 84 113 114Ratio of Rural toUrban 1.34 2.45 4.92 2.78
Sonali Rural 29 28 117 72 127Urban 22 22 33 37 11Ratio of Rural toUrban 1.32 1.27 3.55 1.95 11.55
NCBs: Nationalized Commercial BanksSource: Bangladesh Bank Bulletin, :Scheduled Bank Statistics and Sonali Bank
Annual reports.
- 66 -
(b) The use of BKB would have necessiated provision of refinance,
which would inevitably have been limited by overall monetary base
expansion
(c) The NCBs growing branch network in rural areas and their latent
capacity for rapid expansion of the branch network in rural areas.
In addition to the Special Agricultural Program (SACP) the linkage
between the rural and urban branch licensing was a major method used. These
licenses for new branches were linked in a theoretical ratio of 1 urban to 2
rural. Table 21 gives the urban and rural branches for all NCBs and for
Sonali bank. Between 1976 and the ratio actually fluctuated between 1.3 and
4.9 with an average ratio of 2.7 over the entire period. There was also
considerable variation among banks as is shown by the case of Sonali bank
where the ratio varied between 1.3 and 11.6. For Sonali the average for the
period 1976 to 1980 was 2.9. Thus the expansion was forced by the Bangladesh
Bank and the government at an even faster rate than suggested by the professed
ratio of 2.
As there is an excess demand for urban branch licences, the idea of
the linkage is of course to cross subsidize rural banking operations with
urban. Table 22 gives an estimate of the administrative costs for rural
branches. If the very high initial costs when volume of business is very low,
were ignored, the average cost lies between 4.2% and 5.3% of the volume of
business (deposits plus loans). Total administrative costs (for Sonali bank)
as a percentage of business volume, are between 1.5% and 1.7% (table 23). If
this is taken as the upper limit of costs for urban branches, the minimum
difference in costs is between 2.7% and 3.6% (The minimum ratio of rural to
urban costs is 3).
- 67 -
Table 22: Administrative Cost of Rural Branches
Average Size Business Administrative Cost as a(Taka thousand) Percentage of Business
477 17.3'1,028 8.41,623 5.31,945 5.02,509 4.82,991 4.83,733 5.34,765 4.2
Note: The national average for the size of business of a Sonali branch was16,669 (Thousand Taka) in 1979 and 19,164 (Thousand Taka) in 1980; theadministrative cost as a percentage of business was about 1.8% for thetwo years.
* Computed from a sample of 10 rural branches that have been inoperations since 1978 or earlier. -
** Size of Business is defined as the sum of total deposits andoutstanding advances.
Table 23: Sonali Bank Statistics(in 1000 Taka or p.9 as applicable)
Dec.1976 Dec.1977 Dec.1978 Dec.1979 Dec.1980
Deposits 38441 46615 59950 83879 109666
Advances 24189 36248 48330 67559 96263
Total Business 52620 82863 108280 151438 205929
Interest Paid 1118.96 1479.63 2104.23 2759.46 4742.38
Expenditures 921.45 1230.99 1889.19 2387.90 3485.22
Interest Cost/Advances 4.63% 4.08% 4.35% 4.08% 4.93%
Interest Costs/Deposits 2.91% 3.17% 3.51% 3.29% 4.32%
Admin. Costs/Advances 3.81% 3.40% 3.91% 3.53% 3.62% 0
Admin. Costs/Total Business 1.75 1.49 1.74 1.58 1.68
Ratio of Rural to Urban Branches 1.25 1.58 1.63 2.01 2.09
Growth in Expenditures 309.54 658.20 498.71 1097.32
Rate of Growth 33.59% 53.47% 26.40% 45.45%
Source: Sonali Bank Annual Reports
- 69 -
To calculate the approximate profitability we take all costs as a
proportion of deposits. From Table 22 we can take an average cost of 4.8%
which translates approximately as 9.2% of advances. We can similarly use 3.2%
(1.6x2) as the corresponding figure for urban branches. Interest costs as a
proportion of deposits similarly averaged 4.4% of deposits over the period
1977 to 1980. Interest ceilings were at 12% during this period. Therefore
rural loses are approximately 1.6% of advances while urban profits are
approximately 4.2% a ratio of 2.6. This is very similar to the ratio of new
rural to urban branches for Somali. This is (merely) suggestive of the fact
that not too much incentive existed and pressure had to be applied by the
government. The declining ratio of total new rural to total new urban
branches since 1978 is also consistent with this picture. So is the recent
proposal by the NCB's suggesting Et transfer of their unprofitable rural
branches to BKB.
IV. ISSUES OF FINANCIAL POLICY
4.1 Efficiency or Inefficiency in Credit Markets
I have shown elsewhere that when an inefficiency exists in the
credit market the expected marginal product of the loan will be different from
the marginal cost of funds to the banks (deposit rate i in free market) plus
the marginal cost of transferring these funds from depositors to borrows
(marginal administrative costs of the banks). In the case of usual concern,
when loans are thought to be inadequate, the expected marginal product of
loans will be greater than the marginal costs mentioned above.
The important thing to note is that the relevant interest rate is
not the loan interest rate (r). It: is sometimes thought that r is just the
marginal costs of funds or the deposit interest rate i (or i+t) adjusted for
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risk. This is not true. Both the loan rate (r) and collateral (C) take
account of the risk of non-repayment, and the loan interest rate r does not
bear any definite relationship to the marginal product of loan or capital even
in an efficient market Virmani (1982).
Given the scope of the study it was not possible to. estimate the
marginal product of loans in the various subsectors where inefficiency may be
a possible justification of intervention in the credit market. Some attempt
was made for the agricultural sector (see section 5.2). We are therefore left
to make intuitive judgement.
4.2 Welfare Objectives and Credit Markets
There are two welfare issues which are directly related to the way
in which credit markets function, and which can therefore legitimately be
addressed through credit policy. The more important one relates to the
unequal distribution of wealth or land: this can lead to an inefficient
distribution of credit for productive purposes and possibly even for
consumption purposes. To some extent this is not really a welfare issue but
an issue of inefficiency. The less wealthy or landless producers have little
collateral and can therefore run into a collateral constraint. This results
in less than efficient flow of loans to them at higher interest rates. A
collateral subsidy has been analyzed and suggested as the best policy
intervention in this case.
This is a welfare issue only in the sense that a distributional
problem results in credit problems which can in turn worsen income
distribution. One can of course argue that we should go to the source of the
problem; the unequal distribution of land or total wealth. To the extent that
it is the credit factor which adversely effects income flows and subsequent
wealth distribution, however, this is the causitive factor.
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The second issue is one of the distribution between lender and
borrower of the gains from the credit transaction. This question has most
often arisen in terms of monopolLstic money lenders. It can be shown [Virmani
(1982)] that when there are no informational inefficiencies present,
competitive and monopolistic credlit markets are equally efficient as far as
production loans are concerned. However in the latter case the lender obtains
the benefits from the credit transaction. In effect most of the productive
surplus generated by the use of credit is transferred to the monopolist. In
addition when information problemns exist, a monopolist will be less efficient
than a competitive market, given the same information problems. In a dynamic
context, however, the monopolist has a greater incentive to collect
information which will eliminate the inefficiency (this case was not
explicitly modeled).
Nevertheless, it can be legitimate for government financial policy
to attempt to promote competition and eliminate monopoly. In addition to any
distributional gains this may also have possitive production effects (again in
a dynamic sense) which must be weighed against the costs of intervention. It
is necessary at this point to consider the faulty logic and emotionalism that
characterises policy related to money lenders. Usually they are thought of as
exploitative monopolists who charge very high rates of the order of 100% to
150%. If this is true, tremendous welfare gains would be made if
institutional banks could make cr,edit available in these areas even at rates
of 30-35%. Absolutely no case can be made in this context for putting loan
interest ceilings which are even 'Lower than in competitive institutional
credit markets.
On the other hand if the money lender's loan rates are in the 30-35%
range, these could still be due to monopoly, but can also be due to several
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other factors. The most important [see Virmani (1982)] are information
problems which can provide (ineffect) an informational monopoly by
moneylenders in small localized regions. The effect of these is to severely
fragment the credit market and impair the flow of funds within the rural
areas. In such a situation it is worth considering policies which increase
the incentive for moneylenders to compete in areas outside their traditional
information field. Among the possible policies are increased competition from
formal banks, increased supply of funds to moneylenders in deficit areas, and
increased opportunities for financial investment/savings deposits in surplus
areas and in the surplus (usually post-harvest) periods.
The Rural Financial Experiment project in Bangladesh has used
(experimental) interest rates ranging from 15 to 36%. The recovery
performance has been quite satisfactory at the end of this range. This may of
course be due to the tremendous subsidy provided to banks for recovering
loans. On the whole, however, the evidence from this project is consistent
with the above analysis.
4.3 Differential Interest Rates: Availability vs. Cost
In the simplest terms the institution of interest rate ceilings on
credit has been seen as a conflict between credit availability and costs.
Those who get the loans are seen to have got subsidized credit, while many
people end up not getting it. The actual picture is more complicated: The
direct effect of (loan) interest rate ceilings will be to reduce credit to all
borrowers. Indirect effects can reverse this fall for favored borrowers if
ceilings are economy wide. In addition a (direct) rise in collateral
requirements will result in some borrowers not getting credit at all (for the
first time).
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The simple picture when used for the case in which ceilings are
applied only to one sector concludes that borrowers in that sector get
subsidized credit. It usually neglects both the reduction in credit to
individual borrowers as well as the reduction in the number of borrowers.
More importantly, there will also be a shift of credit away from the chosen
sector, further reducing credit. Thus instead of getting 'subsidized' credit
many borrowers within the sector would get less credit.
The differential credit ceilings introduced in Bangladesh in 1981,
presumably to 'subsidize' certain sectors like agriculture and exports would
have a perverse effect on these sectors. There is already some
impressionistic evidence of an unfavorable intersectoral shift. Once this
becomes clearer the government will have to choose between maintaining the
have a perverse effect on these sectors. There is already some
impressionistic evidence of an unfavorable intersectoral shift. Once this
becomes clearer the government wiLll have to choose between maintaining the
inverted structure and forcing btnks to maintain the desired portion of
lending, or evening out the pattern of ceilings. I would recommend the latter
solution; to be achived by a rise in the interest rates. If a subsidy is to
be provided it should be an interest rate subsidy to banks for lending to
favored sectors. This could be financed by a tax on all other lending. Both
these would shift credit in the desired direction.
4.4 Financing of Specialized Banks: Refinance, Debentures or Deposits
There are many different specialised banks, and many different ways
of financing them. The three most important are Refinacing, Reserve
Debentures, and Deposits. Refinancing is the primary means of financing the
agricultural banks -- BKB and BSBL. A secondary and much smaller source of
deposits for BKB, a scheduled bank, is bank deposits. BSBL being an apex co-
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operative bank is allowed to collect deposits from members only. Reserve
Debentures eligible for fulfillment of reserve requirements by commercial
banks are a major source of funds for the House Building Finance Cooperative
(HBFC), and also a source for the Bangladesh Shilpa Rin Sangstha (BSRS) which
makes medium/longterm loans to industry. The third major source is
deposits. The IRDP Co-operative system is financed indirectly by Sonali Bank
deposits, while the Bangladesh Shilpa Bank (BSB) which can directly take
deposits, has deposits and foreign financing as its primary source.
In economic terms direct provision of refinance to a specialized
bank is exactly equivalent to allowing the bank to issue debentures, and
increasing the reserve requirements of deposit taking institutions to ensure
absorbtion of these debentures (I assume that the public market is limited as
it is in Bangladesh). This follows from the assumption that monetary
expansion is equal in the two cases. In other words any practical difference
arises only if the goverment is led to expand money supply by different
amounts in the two cases. All other things can be made equal by an
appropriate choice of the interest rate on debentures.
Consider first the provision of refinance R to the specialized bank,
which is then fully on-lent by the bank. If money supply is to be unchanged,
the reserves of the banking system must fall by an amount R ; because the
first round effect is -(l-a)R, we must have R' - R= a This can be done by
increasing the reserve requirement by a proportion da - R where MB isa (l-a)MB
the monetary base. If the same amount of finance is to be provided to the
specialized banks through issue of debentures, the value of such debentures is
equal to R. To accomodate these into reserves, reserve requirements must
change by R (i.e., da - R/D) where D is the amount of deposits. The first
round effect is to reduce commercial bank loans by Dda which is equal to R, so
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that money supply is unchanged.
Both these policies transfer loanable funds from the commerical
system to the specialized banks. The required change in reserve requirements
will in general be different (1 - a)MB in the first case and -D in the
second. However both policies provide a cross subsidy from the commercial to
the specialized bank, and the interest rate on debentures can be set to make
the subsidy equivalent.
Consider first the simple free deposit market case. We have shown
earlier that, if transaction costs; are ignored, the effective cost of deposits
to the commercial banks is given by i = i big where i is the nominal cost1a
of deposits, a the reserve requirement, and b the proportion of reserves held
in a debentures earning interest ig. It is easy to show that a change in
reserves will raise, leave unchanged or lower the effective cost i' as i is
greater than, equal to or less than bi . In the present case
b = .2 - 4 Thus setting ig around 1.25i would mean that both policies have.25 5'
no effect on the commercial banks. As the current average i = 7% and the
current rate on government securities is 8.5% we have big = 6.8 which shows
approximate neutrality of interest with respect to reserve requirements. A
provision for equal taxation of commercial banks in the two policy cases would
involve setting the interest rate on debentures (igl - ig2) lower than 8.5 andi - abi 1 i-abig2
making (1-a)MB aD
In the more realistic case of government fixed deposit interest
rates and exogenously given deposits, the banks earn an oligopoly profit per
unit of loan equal to the difference between the shadow/opportunity cost(s)
and the interest cost. Loanable funds would be changed by .R in the
refinance policy case, and by R in the reserve debenture policy case.
Therefore in addition to the factors considered above tax equivalence must
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also adjust for the different amounts of rent transferred under the two
policies i.e. [ R (i-abig) (1 + (1 - a)(iabi)(1 + (1-a)2 ga1 -B) - a a) g2J aD
In this exogenous deposit case, if deposits could be switched
(somehow) from commercial banks to the specialised banks without changing
reserve requirements, there would be no monetary affects. Only a transfer of
oligopoly rent woud take place. In the Sonali Bank -- IRDP case it is not
really a transfer of deposits from a bank to a specialised program, but an
induced transfer of loans from one sort of borrower to another. An implicit
deposit transfer mechanism is involved in BSRS financing: To an extent it was
favored in the grant of licences to open urban branches, and allowed to pay
higher interest rates (still less than s) to depositors.
Some of the more practical considerations can now be illustrated by
evaluating different means of financing the agricultural credit system (BKB,
BSBL, IRDP). The main criticism of the use of refinance as a method of
supplying funds to BKB and BSBL is that agricultural credit becomes too
dependent on global monetary policy and inflation considerations. This is
particularly true in times of high government deficits when there is internal
and external pressure to reduce inflation. Our analysis shows that this is
only valid if reserve requirements are held fixed. If reserve requirements
are made flexible, monetary policy can be delinked from the use of refinance
or the reserve-debenture policy.
When macro policy considerations dictate injection of liquidity into
the system refinance policy is a more direct and simple way of providing
funds. The reserve debenture policy is more disruptive, requiring injection
of reserves into the whole system followed by changes in reserve
requirements. Until about 1979/1980 Bangladesh government deficits and public
sector losses were such as to provide sufficient scope for injection of
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liquidity through refinance. It was therefore the preferred policy during the
period. With the recent reversal of this position pressure has grown on the
BKB to depend to a greater extent on its own deposit resources.
In such a situation an alternative deposit based policy can be
considered. At present both BSBL and the IRDP system are permitted to take
deposits only from members. Serious consideration should be given to allowing
them to collect deposits from, or offer short-term financial instruments to,
the rural public. This would bring them on par with BKB. BKB (and the
cooperatives) is not permitted to have urban branches, while the commercial
banks can open rural branches and in fact have been forced and/or encouraged
to do so.
One possibility would be to allow BKB to open urban branches. This
would tend, however, to progressively dilute the agriculture-rural orientation
of the BKB. An alternative possibility emerges from looking at Table 20 which
gives the credit-deposit ratios by district. The credit deposit ratios for
the rural areas have grown progressively from 32% in 1976 to 69% in 1980, but
still remain below the 75% level possible without any refinancing (at the
prevailing reserve ratio). Even though there is considerable variation
between districts -- 27% in Chittagong to 160% in Mynemsingh -- the 69% ratio
suggests that agricultural lending; could be suppported by rural deposits,
without any need for external finance or refinance. Two methods for doing
this are available.
One method for increasing the flow of deposits to BKB, is to
transfer all rural branches of the NCBs to BKB. This alternative is suggested
by the expressed desire of NCBs to get rid of their many unprofitable
branches. As we shall show below their agricultural lending experience has
not been entirely satisfactory. In addition BKB is quite willing to take over
Table 24: Credit/Deposit Ratios by District (x)
FY 76 FY 77 FY 78 FY 79 FY 80
Urban Rural Urban Rural Urban Rural Urban Rural Urban Rural
A. CHITTAGONG 43 25 47 29 53 45 48 31 54 42
Chittagong 48 18 51 63 56 36 53 19 60 27
Chittagong Hill tracts 21 141 21 35 30 48 34 46 24 193
Comilla 27 47 40 63 49 74 43 46 47 83
Noakhali 37 31 53 44 61 63 55 65 65 77
Sylhet 32 14 27 19 34 32 26 23 30 27
B. DACCA 119 45 110 52 112 72 11 77 119 84
Dacca 126 41 115 45 116 55 1l1(?) 50 122 53
Faridpur 33 41 61 56 56 82 50 90 58 107
Mymensingh 31 57 40 79 56 113 55 160(?) 61 160 X
Tangail 23 38 40 28 40 66 46 82 48 92
Jamalpur NA NA NA NA NA NA 101(?) 123 103 172
C. KHULNA 57 28 66 56 74 60 77 47 78 98
Barisal 20 30 29 56 36 81 33 54 40 79
Jessore 34 22 99 43 53 58 54 82 57 122
Khulna 85 25 84 60 96 59 100 65 94 94
Kushtia 28 13 45 45 49 52 53 15 74 69
Patuakhali 27 69 53 110 57 103 56 129 69 178
D. RAJSHAHI 27 33 37 50 42 76 46 82 47 92
Bogra 30 32 35 43 47 55 52 59 51 66
Dinajpur 27 58 31 97 32 143 31 128 40 135
Pabna 14 22 65 30 38 58 52 63 38 65
Rajshahi 21 19 33 91 37 52 33 57 34 67
Rangpur 42 51 56 71 58 100 68 127 50 150
Total 86 32 84 43 89 59 86 51 95 69
Source: Bangladesh Bank
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these branches. If rural branches were transferred to BKB the primary
responsibility for providing funds; to BSBL and IRDP would be transferred to
BKB.
An alternative method for linking the flow of funds to agricultural
banks with rural deposit mobilization is to make it mandatory for nationalized
banks to transfer all excess reserves from their rural operations to BKB, BSBL
and IRDP. This transfer would be in the form of loans at rates which take
account of interest payments and administrative costs. In other words BKB,
BSBL and IRDP would have the right to borrow from the NCBs the difference
between the loanable funds generated by rural deposits and the loans made in
rural areas. This proposal is likely to be more acceptable to NCBs, but more
difficult to implement because of the problem of defining rural areas and
rural loans. Some mix of the two maethods may prove to be more feasible.
4.5 Buffer Stocks: Alternative for Margin Requirements and Refinance
When analysing margin requirements it was suggested that they may be
useful for agricultural commodities. As buffer stocks fulfill the same price
stabilizaton function it is useful to briefly consider the two together. As a
general principle buffer stock policy is more relevant for commodities whose
prices fluctuate regularly on a seasonal and/or annual basis. Margin
requirement changes are more appropriate for unexpected and temporary changes
in prices. Put somewhat differently buffer stocks are more appropriate when
production fluctuates from year to year or when havesting is concentrated at
one point in a year, resulting in a strong seasonal fluctuation in prices
(i.e., demand is uniform). Margin requirements are more appropriate when
unexpected economic events lead to strong speculative demand.
Buffer stocking and refinance are not as clearly separable. Buffer
stocking would itself give rise to a cyclical, seasonal or annual, pattern of
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demand for credit. In the seasonal case the cycle is exactly the inverse of
the demand for credit for agricultural production of the corresponding
commodity. Therefore if both sets of borrowers were supplied from an
integrated financial system, cyclical demand fluctuation would be eliminated
and there would be no need for special refinance. On the other hand annual
cycles would still lead to annual fluctuation in credit demand from the
stocking agency. If the buffer stocking operation is self supporting (after
taking account of explicit budgetary subsidies) the banking system woud
generally be willing to supply the required credit.
4.6 Term Finance
In the agriculture area there is strong push for providing medium,
and long term finance for irrigation improvement. In industry the specialised
banks, Bangladesh Shilpa Bank (BSB) and Bangladesh Shilpa Rin Savings (BSRS),
are there specially for providing term finance. I have shown elsewhere that
term lending creates special problems for banks because of the difficulty of
distinguishing between productive and unproductive, and honest and dishonest
borrowers. Both problems have arisen in the case of term lending for
industry. Industrial lenders can borrow up to 70% of the cost of a new
project from BSB. Additional loans of up to 15% can be obtained from ICB and
IFC. By inflating the cost of imported machinery (overinvoicing) and of land,
and covering the difference from the public (shares) the promoters can end up
by not using any of their own funds. Thus they may have little commitment to
the success of the project, resulting in poor repayment performance.
As I have shown it is necessary in such situations to develop
procedures for distinguishing between productive and honest borrowers and the
rest, and restricting loans to the former. A World Bank research project on
Kenya is attempting to develop such procedures. Similar work has also been
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done in a neighboring country. Use should be made of these and other
attempts, to do the same thing in Bangladesh. Other suggestions are made in
the financial review of Industrial Sector lending.
V. AGRICULTURAL CREDIT
5.1 Introduction
The explicit purpose of agricultural credit policy has been to
promote the growth of output and the welfare of farmers. The first goal
implies either that rural credit markets are inefficient or that credit is an
effective means of providing a production/investment subsidy to
agricultural. If rural credit markets are inefficient, then effective
intervention could promote output growth by improving efficiency. On the
other hand a determination of whether a production subsidy should be provided
through credit requires a prior exaLmination of the incidence of taxes and
subsidies on fertilizer, irrigation water, irrigation equipment and output.
Once a neutral policy environment is created, it cannot be ruled out a priori
that an explicit credit subsidy (not interest ceilings) may be one component
of an integrated subsidy package.
The second policy objective of increasing farmer welfare can relate
to the entire agricultural sector, or to sub-sets of farmers, usually the poor
and landless. An appropriate production subsidy package is one means of
increasing farmer welfare if accompanied by measures to market the output and
minimize any adverse impact on output prices. The other welfare question
relates to the distribution of gains between traditional lenders and farmer
borrowers. This has been addressed earlier.
Returning to the question of credit market efficiency, there are two
opposing views on the matter. One view is that if agricultural productivity
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increases due to introduction of HYVs enough credit will be generated to meet
demand. In other words the existing level of technology and non-credit
related constraints-risk, availability of water, technical knowledge etc., are
significantly more important factors. The other view is that rural credit
markets are very fragmented, and excess funds do not flow smoothly from
surplus to deficit areas. This causes inefficiencies in credit markets.
5.2 Expected Marginal Product of Loans
In an earlier paper I have given a method for measuring the degree
of inefficiency, if any, in the market. I have also shown that if there is
any inefficiency in rural markets it is probably not due to the physical
problem of moving funds. Any inefficiencies arise due to informational
problems which constrain traditional lenders, and new potential lenders, from
providing credit in unfamiliar areas and to unfamiliar borrowers. I have
shown that if the credit market is functioning efficiently, the expected
marginal product of loans must be equal to the opportunity cost of loans. The
latter is the marginal cost of raising deposits plus the marginal cost of
transferring them to borrowers (marginal administrative costs). The average
cost of funds in 1979-80 was 4.3% of deposits (Table 17). The rural
administrative cost, for commercial banks have ranged around 10.6% of deposits
(from a sample of Sonali branches, 2 x 5.3). This yields an approximate
average cost of 15%. Though administrative costs for the agricultural banks
may be lower, a figure of 15% can be used for illustrative purposes.
To obtain the marginal product of loans, we use the fact that
fertilizer input and the output resulting from it are separated by the
produttion period for crops. Consider a simple case in which fertilizer input
is separated from agricultural output by T months. Use of fertilizer
therefore requires use of own funds or credit to purchase fertilizer. Any
Table 25: Marginal Product of Loans in Agriculture
Marginal Product Price Fertilizer 1 2 Time Period Annualizedof Fertilizer at (Adjusted) Price p 3 1 of Production Rate or ReturnAug. level of use (TK/md) A 3 (months) 5 x 12/T
1 2 3 4 5 6
1. Aman 1979, Local, Broadcast 2.03 125 137.4 .846 10 1.02HVUW, Transplant 2.46 120.9 137.4 1.165 9 1.55
2. Boro 1979-80, Local 4.53 122.65 180.5 2.078 7 3.56HYU 2.74 109.51 180.5 .642 7 1.10
3. Aus 1980, H UW, Broadcast 2.01 93.60 182.7 .029 6 .06
4. Aman, 1980, Local Transplanted 3.91 117.38 186.6 1.460 9 1.95
Source: IFDC/BARC, Agricultural Production, Fertilizer Use and EquityConsiderations, Results and Analysis of Form Survey Data, 1979/80,Bangladesh 1981.
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credit taken is then repaid T periods later. It is easy to show that the T
month rate of return on loans is (p. MPF/pF - 1) where p is the output price,
PF the fertilizer price and MPF the marginal product of fertilizer. If
fertilizer is not used efficiently because of rationing, the marginal product
of loans will be less than this amount.
Table 25 presents estimates for the marginal product of loans using
estimates of the marginal products of fertilizer at average levels of usage.
A reasonable assumption might be to assume that fertilizer usage is efficient
in HYV crops, but may not be so in traditional. The second thing, to keep in
mind is that high rates of return for short periods do not necessarily
translate into the high rates suggested by simple annualization. This is
because the opportunities available for the rest of the periods may be quite
restricted due to market inefficiencies. The estimated annualized rate of
return on loans for HYV crops varies from 6% for 1980 Broadcast Aus to 155%
for 1979 Transplant Aman, with 1979 Boro in the middle with 110%. Given a
cost of funds of 15% a rate of return of 6% would suggest an excessive use of
fertilizer which is very unlikely at average levels of fertilizer usage. Some
upward adjustment may also be required for the fact that 1979 and 1980 were
bad crop years and what we need is an average of the marginal product over
several years. As most HYV are grown in irrigated areas, fluctuations in
their output is much less (flooding, can still be a problem). A 9 percentage
point difference is hard to explain on this basis given the high returns from
other crops in the same period.
A possible explanation for the 1980 Aus and 1979 Boro is under use
of fertilizer due to shortages and rationing. In such a situation the
calculated rates provide an upper limit, and actual returns on loans would be
less. However there is no evidence to suggest that there was a shortage
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during this period. Sample testing done by BADC indicates that free market
prices were not significantly diffierent from controlled prices.
The rates of return calculated from traditional varieties show
somewhat less variation ranging from 102% through 195% to 365%. Such high
rates are somewhat unbelievable, particularly in bad agricultural years. The
caution about annualizing rates is of course very relevant here, but even the
unadjusted returns range from 64% t:o 146%. The tentative hypothesis about
more efficient use of fertilizer in HYVs than in traditional crops, is
supported by the 1979-80 Borro returns but contradicted by the 1979 Aman
returns.
If one could ignore the 6% return, the rest of the data become
fairly consistent, indicating a minimum expected marginal product of loans of
100%. This suggests enormous inefficiency in the agricultural credit market.
We cannot just ignore the anomalous observation, however, and any judgment of
credit market inefficiency mtust be tempered by caution.
5.3 Targets and Disbursements: Differential Performance
Almost the entire gamut of policy instruments has been applied to
agricultural credits. This includes targets, refinance, guarantees, branch
licensing and special programs. In addition interest rate policies, margin
requirements and credit ceilings also impinge on agricultural credit. Among
the earliest to be used was the target guideline approach. Table 26 presents
the targets, disbursements and achievements of BKB, BSBL and the NCBs for the
1975-81 period.
In 1975-76 the target for total disbursements was TK 49.56 crore
while achievement was at TK 48.29 crore or 97% of the target. By 1980-81 the
targeted disbursements had more than tripled to TK 3438.31 crore while
disbursement had increased only to TK 279.6 crore showing a performance of
Table 26: Agricultural Credit
(in lakh takas)
TARGET 1974-75 1975-76 1976-77 1977-78 1978-79 1979-80 1980-81
BKB 1672 2200 3635 4323 6588 10300 17986BJSB/BSBL 1300 1550 2000 2200 2475 2900 3800
Sub-Total 2972 3750 5635 6523 9063 13200 21786NCB's 1600 1206 2835 4714 6654 7530 13045
Total 4572 4956 8470 11237 15717 20730 34831
DISBURSEMENT
BKB * * 3168 3729 5867 11896 18532BJSB/BSBL * * 1133 1705 2010 14600 2570
Sub-Total 2605 2768 4301 5434 7877 14600 21102NCB' 881 2061 2194 3654 5069 5536 6858
Total 3486 4829 6495 9088 12946 20136 27960
ACHIEVEWC'NT: Disb/Target X(%)
BKB 87.15 86.25 89.05 115.49 103.04BJSB 56.65 77.5 81.21 93.24 67.63
Sub-Total 87.65 73.81 76.33 83.31 86.91 110.61 96.86NCB's 55.06 170.89 77.38 77.51 76.79 73.52 52.57
Total 76.25 97.44 76.68 80.88 82.37 97.13 80.27
Rate of Growth of Disbursement
BKB 17.71 57.33 102.76 55.78BJSB/BSBL 50.48 17.88 34.53 -4.96
Sub-Total 6.25 55.38 26.34NCB's 133.94 6.45 66.55 38.72 9.21 23.28
Total 38.53 34.50 39.92 42.45 55.75
* Not availableBKB: Bangladesh Krishi BankBJSB/BSBL Bangladesh Jatigo Sumabaya Bank/Bangladesh Samabaya Bank Limited.Source: Annual Reports of the Bangladesh Bank
- 87 -
80%, the lowest level since 1976-77. Just as targets were designed to provide
an impetus to disbursement the actual disbursement performance influences the
setting of targets. Nevertheless the disbursement performance has varied
considerably over time and between the banks.
Both BKB and BSBL showed improved performance in terms of targeted
disbursement over the period 1976-77 to 1979-80, but then performance
plummeted quite sharply in 1980-81 (Table 26). In contrast the commercial
banks' performance shows a deteriorating trend over the period, going from 77%
in 1976-77 to 53% in 1980-81. BKB performed the best in terms of targets,
with a peak of 115% in 1979-80, and with 103% even in 1980-81. After the
early period BSBL's performance and has remained between these two in terms of
targets.
Total disbursements rose at a rate of 44% a year between 1976-77 to
1980-81, from TK 64.95% crore to TK 279.6 crore. However much of this growth
was due to expansion in lending by BKB which rose from TK 31.68 to TK 185.32
crore an overall compound rate of growth of 56% a year. The growth rate for
the commercial banks was 33% a year, and for BSBL only 23% a year. This
contrasts with the relative posiltion of the last two when compared on a
target-achievement basis. It also suggests that the government and the
Central Bank, perhaps, expected tWoo much from the commercial banks. The 33%
growth rate includes Sonali Bank lending to the IRDP co-operative system, in
which the former acts merely as a conduit. The commercial banks' performance
viz a viz direct lending to fina:L borrowers may not match this growth.
The BKB's performance sieems by and large to have matched
expectations. Thus for example the rise in targets from TK 65.88 crore in
1978-79 to TK 103.0 crore in 1979-80, was accompanied by a rise in
disbursement performance from 89% to 115% of target (A 102% growth of
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disbursement). As a consequence BKB's share of total disbursements has risen
from 49% in 1976-77 to 66% in 1980-81. A major policy instrument affecting
this performance has been the refinance policy coupled with specialization.
Refinance policy was analyzed earlier. Being a specialized agricultural bank
BKB is excluded from non-agricultural lending, though trade, storage and
processing activities, particularly in rural areas, come within its purview.
In addition specialization has yielded information economies which resulted in
better performance. This is independently indicated by its recovery
performance which will be analysed below. An additional factor in past growth
performance is that the BKB has not been formally subject to credit ceilings
on agricultural lending (nor has the BSBL).
5.4 The Special Agricultural Program and Commercial Bank Performance
Table 27 gives the targets and disbursements under the Special
Agricultural Credit Program (SACP/TK 100 crore program). Disbursements
increased from TK 60.78 crore during 1977 (calender year) to TK 72.68 crore in
1980-81 (financial year), a total growth of only 20%. Achievements as a
proportion of targets were equally disappointing, declining progressively from
61% in the 1977 program to 36% in 1980-81 program (Table 27). For the first
two years the program was on a calendar year basis, so that the data is not
directly comparable to that in Table 26. If we take an average of the total
disbursement for 1976-77 and 1977-78 from this table, however, we obtain an
approximate figure of TK 77.92 crore for calender year 1977. Of this,
disbursement under SACP 1977 which started only in February was TK 60.78 crore
or 78% of the total. This gives some idea of the (initially) ambitious scope
of the program and the pressure put on commercial banks to increase
agricultural lending.
- 89 -
Table 27: Special Agricultural Program (SACP/100 crore)(In 1000 Taka)
SACP Program of: 1977 1978 1979 1979-80 1980-81
Total Under SACPTARGET 10000 10000 5715 10000 20000DISBURSEMENT 6078 5347 2370 4127 7268
ACHIEVEMENT 60.78 53.47 41.46 41.27 36.34(Target/Disbursement)
As of: Dec.1977 Dec.1978 Dec.1979 Dec.1980
Outstandings
Sonali BankSACP 1000 1659 2737 4250Normal Program 653 971 1556 3050IRDP 721 1084 1960 3514Total 2374 3714 6253 10814
Agrani BankSACP 745 1002 1302 1620Normal 43 40 304Total 7138 1042 1606 *
NCB sTotal 3938 9216 15063 10570@
* Not available@/ Provisional.
- 90 -
The push didn't last long however, as by the next year, SACP
disbursements at TK 53.47 crore were only 49% of total (again taking 1977-78
and 1978-79 average for total disbursement). By 1980-81 SACP disbursements
were only 26% of total disbursements.
As one of the major purposes of the SACP was to bring NCBs into
agricultural lending, we would expect its greatest impact on their
agricultural lending. The data on the outstanding loans of Sonali Bank and
Agrani Bank (Table 27) is consistent with this. Though the figure for
outstandings includes overdues, the SACP outstandings for December 1977 will
include no overdues while those for the normal program do. Leaving aside IRDP
lending by Sonali, both banks had a major proportion of their disbursements
channeled through the SACP (Table 27). This clearly remains true for the
Agrani Banks until 1980-81; but less so for Sonali Bank, if allowance is made
for the possibility of higher overdues under SACP than under the normal
program. The major increase in the rate of growth of commercial banks
disbursements (Table 26), from 6% in 1976-77 to 67% in 1977-78 can be largely
attributed to the SACP program.
The rate of growth of loan disbursements by NCBs slackened somewhat
to 39% in 1978-79 and then plummeted to 9% in 1979-80. We have already shown
that disbursements by all banks under SACP as a proportion of total
disbursements also declined in absolute terms. Therefore part of the still
fairly high growth rate of 39% in NCB loan disbursements must be due to
increased lending under the normal program. This is suggested by the
gathering momentum of the rural branch expansion program. The ratio of new
rural to new urban branches of NCB grew from 1.3 in 1976-7 to 2.5 in 1977-8
and to a peak of 4.9 in 1978-9 (Table 21). The banks' loan disbursements
under SACP continued to slacken, however, and reached 68% of first year (1977)
- 91 -
levels in 1979-80. The growth oil rural branches also registered lower rates
in 1978-79 and 1979-80 (Table 21), suggesting a slackening of the rural
program. Loan disbursements by 21CBs therefore increased only by 9% in 1979-
80. A major causative factor was the much more rigorous application of credit
ceilings on commercial banks in 1.979-80. Though these ceilings had been in
operation for sometime, and NCBs' agricultural lending fall within their
ambit, aggregate inflationary pressures and IMF related contacts led to
increasingly forceful application.
5.5 Introduction of Urban Organised Banks into Agricultural Lending
Throughout this experience or experiment of getting the NCBs into
agricultural lending there has been a feeling that the distribution of credit
has not been satisfactory. In particular it has been felt that tenants and
small farmers are not getting enough credit. These effects are predicted by
my earlier analysis (competitive monopoly, Virimani (1982)), and I will briefly
outline the implications of the amalysis.
Given the importance of information and knowledge in the operation
of credit markets, urban organized banks are specilized to operate in that
environment. Basically they have developed procedures for dealing with
organized and established firms. When these banks are forced into the rural-
agricultural environment they are confronted with a completely different
informational problem. They will therefore seek out and lend to agricultural
producers who bear the greatest similarity to urban clients. These are
usually the largest, most educatedl and most modern (in terms of irrigation and
HYV technology). This is the group which benefits most from the introduction
of Urban banks. The medium farmers would tend to get some benefit because of
the erosion of monopoly profits of traditional lenders (arising mainly from
informational problems). But they would continue to borrow from them. The
- 92 -
smallest farmers do not benefit at all because the banks have so little
knowledge or competence in dealing with them that they cannot even offer any
potential competition to traditional lenders.
5.6 Interest Ceilings and BKB Performance
Table 28 gives the distribution of BKB loans by land holding and by
size of loans. The proportion of loans going to borrowers having 12.5 acres
to 33 acres of land rose sharply from 5% in 1976-77 to 11% in 1977-78.
Similarly the proportion of loans of amount greater than TK 3000 increased
from 12% to 40% of all loans. There was a decrease in the interest ceilings
in May 1977, but this was not applicable to the BKB and BSBL which already had
lower applicable ceilings. In August 1977 margin requirements of 50% were
imposed on all merchandise. We have shown in the analysis on margin
requirements, that for traditional borrower/merchants there would be a
tendency for loan interest rates to rise and loan amounts to fall. Further
some traders would now not get any loans at all. This provides an opportunity
for large farmers who do not normally engage in trade or in speculative
stocking to do so. Only the largest farmers would tend to have enough own
fund to meet margin requirements. They would thus take larger loans using the
increased part for speculative stocking. This is consistent with the shift in
loans towards the largest land owners from 5% to 11% of total loans. However
there is an increase in loan proportion from 28% to 39% in the 2.5 acre to 7.5
acre group. This suggests that some of the medium size land owners with
surplus funds may also have engaged in speculation.
Different land owners would tend to have different amounts of liquid
funds available for providing margin money. Therefore we do not expect a
proportional shift in the loan amounts taken. Table 28 shows that the
- 93 -
Tables 28: Banfgladesh Krishi Bank Borrower Characteristics
I. Distribution of Loans According to Size of Holding (Excluding Tea, Cold StorageTobacco Marketing & Processing); II. According to Size of Loans; III. According toSecurity Type.
1976-77 1977-78 1978-79 1979-80 1980-81I. % of all loans for year
Land holding of borrowers
Landless and upto 2.5 acres 54.70 39.13 42.74 35.72 32.082.5 to 7.5 acres 27.58 34.19 30.26 26.05 31.337.5 to 12.5 acres 13.10 15.37 13.80 25.36 16.5112.5 to 33 acres 4.62 11.31 13.20 12.87 20.08Total 100 100 100
Cumulative %
< 2.5 54.70 39.13 42.74 35.72 32.082.5 to 7.5 82.28 73.32 73.00 61.77 63.417.5 to 12.5 95.38 88.69 86.80 87.13 79.9212.5 to 33 1001 100 100 100 100
II. % of all loans for year
Loan Size
< TK 1000 53.86 32.83 34.69 24.67 8.231000 to < 3000 34.20 26.50 26.15 18.41 27.753000 to < 10,000 4.07 24.41 20.67 14.53 18.9210,000 to < 20,000 5.38 9.33 11.05 22.06 8.6820,000 to < 50,000 0.19 2.78 4.81 16.39 13.66> 50,000 2.30 4.15 2.63 3.94 22.76
100 100 100 100 100
Cumulative %
53.86 32.83 34.69 24.67 8.2388.06 59.93 60.84 43.08 35.9892.13 83.74 81.51 57.61 54.9097.51 93.07 42.56 79.67 63.5897.70 95.85 97.37 96.06 77.24
100 100 100 100 100
Ill. % of all loans for yearSecurity
Real Estate 33.79 53.16 53.89 38.26 45.01Hypotecation (incl SACE') 61.20 41.86 35.34 55.86 26.04Stored Crop Pledge 2.38 0.26 3.54 3.46 25.87
Source: BKB annual reports.
- 94 -
greatest shift was in the TK 3000 to less than TK 10,000 category, from 4% of
total loans to 24%.
In October 1980 the structure of interest ceilings was changed so
that agriculture was subject to a ceiling of 12%. The general ceiling,
applicable to storage, transport, trade, etc. was much higher at 15.5%. In
the section on interest ceilings it was shown that there would be a tendency
to shift out of agricultural lending into general lending (here it could be
agriculture related). It was shown earlier that BKB's disbursement
performance both in terms of growth rates and in terms of achievement of
targets rose progressively from 1976-77 to 1979-80. This trend was sharply
reversed in 1980-81; The growth rate declined from 103% to 58%, while
performance as percentage of target declined from 115% of target to 103% of
target (Table 26). This was accomplished by a shift of the loan distribution
away from the smallest loans of TK 1000 and less, to those of between TK
1000 and TK 10,000. The former declined from 25% of total in 1979-80 to only
8% in 1980-81, while the later increased from 33% to 47%.
5.7 Recovery performance
Many different measures of recovery performance have been used.
When it is not possible to separate out loans by maturity and by initial
starting time of loan, the best measure is the following: A ratio of the
total repayment during the year to the value of loans plus interest falling
due during that year. Another possible measure is the ratio of the repayment
of principal to the principal due during the year. The latter measure may be
useful when comparing different institutions and programs, with different
mandated interest ceilings or other restrictions. This runs into an
accounting problem, however. Banks which compound interest, transfer all
overdue interest to the principle account, in effect converting it to an
- 95 -
overdue loan. The problem of recovery performance varying merely because of
differences in rates of interest charged, may not be solved.
Another problem with both these measures, when used in a comparative
analysis, is that recovery performance can differ merely because of different
rates of growth of disbursement. ]Non repayment at the due date does not mean
that no further repayments will be made in future years. In fact repayments
are often stretched out over several years. For example, many banks in
Bangladesh are still receiving repayments on loans made in pre-liberation
times. For this reason banks with faster growth in disbursements would tend
to show poorer recovery performance.
A unique set of data is available for Bangladesh which allows us to
look at the pattern of loan repayment for a given loan. This relates to the
SACP/100 crore program, which was started in 1977. In this program all loans
had approximately the same term. Accounts were kept separately for each
years' program. These were initially on a calender year basis, but in 1979
were switched to a financial year basis, with the intervening program lasting
only 6 months. Data on accumulated recovery of principle is available for
each bank and each program at four points of time. A recovery profile can
therefore be constructed given total disbursements under each program for all
banks. A linear regression of accumulated recovery on time from
effective/average due date is used for this purpose. The results for the six
nationalized commercial banks and BKB are presented in Figures 1, 2 and 3.
The results by program are presented in Figure 4.
From Figure 1 it is clear that the recovery profile of the
Bangladesh Krisi Bank (BKB) lies entirely above that of others. This
superiority is more noteworthy given that the BKB's recovery performance under
the SACP is known (even to it) to be inferior to its recovery performance
Figure 1: Recovery Profiles by Banks for the Special Agricultural Credit Program
SONFLL
----------- MRAWRsN*JRNSRT
-. - JAnaT- RUPVLt
*---* PU-MLI
1 40.0- - 140. 0
120.0- 120.0
100.0 1 100.0
80.0 - 80.0
60.0- 60.0
40.0- - 40.0
20. 0 - / - 20. 0
0.0 20.00.0 10.0 20.0 30.0 40.0 50.0
Figure 2: Recovery Profiles: BKB, Sonali, Agrani and Janata Banks
--------
120.0- - 120.0
1 00/ a 10 e.o
60.0- va0,0
40.0 -u40.0
20.20.0 Io.o 10.0 20.0 30.0 40.0 50.
Figure 3: Recovery Profiles: Janata, Uttarg. Rupali and Pubali Banks
1_ _ __ _ _ __0_ __ _ __ _ _ __ _ _ - 2 .
UJJ.I .I 0.0
80.0 .- 80.0
60.0 ,' 60.0 0
°I~~~t-
40.0 . ' 40.0
20.0 - / -0.0
0.0 I -0.00.0 10.0 20.0 30.0 40.0 50.0
- 99 -
under normal programs. From Figures 1 and 2 we can also conclude that Sonali
bank's performance is quite close to that of BKB. It thus comes in the second
position even though initial recovery is lower than for Uttara and Agrani
banks. Given the differences in the intercept terms and slopes it is more
difficult to rank the others. Broadly speaking however, figures 1 to 3 show
that the performance of the BKB, the Sonali bank and the Uttara bank is better
than that of the Janata, Rupali and Pubali banks, with Agrani bank in an
intermediate position. Among the commercial banks the better performance of
the Sonali Bank is probably due to its larger rural branch network at the
start of the program, and its involvement with the IRDP program. The BKB-s
better performance is clearly due to its deeper and longer involvement in
agricultural lending.
Figure 4 compares the recovery performance for the different
programs for all banks taken together. The 1977 and 1978 programs are treated
separately while the 1979 and 1979-80 program data are aggregated so as to
have enough data points. The performance under the 1978 program was
definitely worse than that of the L977 program. There have been wide-spread
complaints of politicisation of the program in terms of the choice of
recipients. If true, this provides an explanation of the deterioration;
political pressures would take time! to build up and take effect. The 1979 and
1979-80 programs show significant improvement over the 1978 program. Their
performance relative to the 1977 pxogram is more difficult to evaluate:
initially lower recovery is made up in subsequent periods because of the
higher marginal recovery rate. At the end of 1979-80 banks were given
permission, independently and directly to select borrowers for the 1980-81
program. This depoliticisation affects the most recent programs more
strongly, but would also effect recovery from older programs. This is a
Figure 4: Recovery Profiler by SACP Programs
...... -------- PRO678
120.0-- 120.0
100.0 _ 100.0
80.0 80.0
40.0 40.0
20.0- - 20.00.0 10.0 20.0 30.0 40.0 50.0
- 101 -
possible explanation for the upward movement in recovery rates for the 1979
and 1979-80 programs.
Another explanation for the improvement in the 1979-80 program is
the introduction of penalty rates in February 1979. Banks were allowed under
this scheme to charge a penalty rate of 1% a month up to a maximum of 20%.
Given the normal interest of 12%, this permitted a rise in the interest rate
on overdue loans by as much as 8%. As all the banks considered, compound
interest, penalty interest rates would tend to raise the average interest
payable, in proportion to the delay in repayment. This would tend to increase
the slope of the recovery profile line for the 1979 and subsequent programs.
The application of penalty rates has however been quite variable, largely
because of lack of clarity about its applicability to SACP and other
agricultural lending. Only Sonali bank is known to apply the full penalty.
The BKB uses a maximum penalty of 2.5%, while Agrani bank uses a penalty of
only 1% for rural loans.
5.8 Bad Debts versus Liquidity Problems
The existence of such a recovery time profile suggests that bad
debts may not be a serious problem in agricultural lending. This is in fact
what most bankers involved in agricultural lending in Bangladesh believe. It
would be wrong to conclude, as some dlo, that there is no problem of bad debts
,,r non-repayment risk; this aspect is not captured well by the indices used
above. The analysis shows, however, that even with the best performance,
recovery of loans may normally be stretched over as much as three years.
I1lerefore liquidity may become a ser3Lous problem, particularly for
1antitutions which depend on refinancing of loans (or total loans minus
wverdues) such as BKB, BSBL and the lRDP system.
- 102 -
In the discussion about the liquidity guarantee it was noted that
BSBL has always used this facility, while BKB has never used it. The previous
section's analysis suggests that this may at least partly be due to the
latter's superior recovery performance (BSBL is not involved in the SACP).
Nevertheless, given the rapid growth of BKB lending in the past five years
liquidity could become a serious problem in future. In addition the
significantly lower rates of interest will no longer be a problem because BKB
can now charge penalty rates on overdues. Therefore the BKB's policy on use
of penalty rates may have to be reviewed to allow full use of permisable
penalty rates.
- 103 -
Footnotes
1/ Resume of Financial Institutions, Ministry of Finance, Government of
Bangladesh 1973 and 1975.
2/ See Introduction and Section 4.5 of Virmani (1982).
R_ferences
1. Virmani, Arvind, The Nature of Credit Markets in Developing Countries: A
Framework for Policy Analysis,World Bank Staff Working Paper No.
524, 1982.
World Bank An Analysis of Developing NEWCountry Adjustment
Publicationis Experiences in the 1970s: Low- Compounding and Discounting
of Related Income Asia Tables for Project AnalysisChristine Wallich (with a Guide to Their
Interest Staff Working Paper No. 487. 1981. 43 Applications)pages (including references). Second Edition, Revised aildStock No. WP 0487. S3. Expanded
Adjustment Experience and Aspects of Development Bank J. Price GittingerGrowth Prospects of the Senm- Management Project planners and analvsts will findIndustrial Countries William sDiMment . this book a convenient and time-sav-Frederick Jaspersen William Diamond and ing reference for the preparation andStFfederikin Pasperseno.47 913 Raghavan- analysis of development projects. Six-Staff Working Paper No. 477. 1981. 132 Deals exclusiveIv with the manage- decimal tables for 1 percent through 50pages (mcludtag 3 appendzxes). ment of development banks. The book percent show the compounding factorStock No. WP 0477. $5. is divided into eight sections, each for I and for I per annum, the sinking
dealing w,ith one aspect of manage- fund factor, the discount factor, theAdjustment in Low-Income ment of its problems, and of the var- present worth of an annuitv factor,Africa ious ways of dealing with them. and the capital recoverv factor. TheRobert Liebenthal EDI Series in Economic Development. The first edition of this book underwentStaff Working Paper No. 486. 1981. 62 Johns Hopkins University Press, 1982. seven printings in ten vears and waspages (including bibliography). 2nd printing, 1983. 311 pages. translated into Arabic, Chinese,Stock No. WP 0486. $3. LC 81-48174. ISBN 0-8018-2571-7, Stock French, and Spanish. This new edi-
No. H 271.$29.5 hrdcver;ISB 0- tion-with narrow-interval compound-Aggregate Demand and 8018-2572-5, Stock No. JH 2572, S12.95 tabes added frhier interestMacroeconomic Imbalances in paperback. rates, updated project examples, aThailand: Simulations with the Capital Accumulation in lators to perforu n the cocputar onsSIAM 1 Model Eastern and Southern Africa: A discussed, and an annotated bibliog-Wafik Grais Decade cf Setbacks raphv increases the proven usefulnessStaff Working Paper No. 448. 1981. 132 Ravi Gulhati and Gautam Datta of its predecessor, both in the class-pages (including 3 appendixes). Analyzes the magnitude of the setback room and at the project site.Stock No. WP 0448. $5. in capital accumulation in eastern and May 1984. About 208 pages.
southem Africa. This phenomenon is ISBN 0-8018-2409-5. Stock No. BK 2409.examined in twentv-eight statistical ta- $10.95.
NEW bles. The authors sample sixteen coun- Translations of this new edition will betries and rely on expert observations to available in 1985. Still available are theexplore the proximate causes of the following translations of the first editzon:
Alternative Mechanisms for setbacks. French: Tables d'interets composes et d'ac-Financing Social Security World Bank Staff Working Paper No. 562. tualistation. Economica, 4th printing,Parthasarathi Shome and Lyn 1983. 74 pages. 1979.Squire ISBN 0-8213-0169-1. Stock No. WP 0562. ISBN 2-7178-0205-3, Stock No. IB 0542,Reviews, clarifies, and evaluates theo- S3. $6.retical literature about the effect of so-cial securitv on capital accumulation Capital Market Imperfections Spanish: Tablas de interes compuesto y deand labor supply. Analyzes empirical and Economic Development descuento para evaluaci6n de proyectos.studies using U.S. data, the impact of Vinayak V. Bhatt and Alan R. Roe Editorial Tecnos, 1973; 4th printing, 1980.pay-as-you-go financed and fully Staff Working Paper No. 338. 1979. 87 ISBN 84-309-0716-5. Stock No. IB 0526.funded social security schemes, and zaages (including footnotes). S6.characteristics of optimal social secu- Stock No. WP 0338. $3.ritv svstems. This studv provides astarting point for evervone interestedin the relevance of existing theories for The Changing Nature of Export A Conceptual Approach to thefinancing social security in developing Finance and Its Implications Analysis of External Debt ofcountries. for Developing Countries the Developing CountriesStaff Working Paper No. 625. 2983. 62 Albert C. Cizauskas Robert Z. Aliberpages. Staff Working Paper No. 409. 1980. 43 Staff Working Paper No. 421. 1980. 25ISBN 0-8213-0292-2.Stock No. WP 0625. pages (including 3 annexes). pages (including appendix, references).$3. Stock No. Wr 0409. 53. Stock No. WP 0421. $3.
- NEW Staff Working Paper No. 632. 1984. 144 Growth and Structuralpages. Adjustment in East Asia
Development Finance Stock No. WP 0632. $5. Parvez HasanC.ompanies, State and Privately Staff Working Paper No. 529. 1982. 42C)wned: A Review NEW pages.David L. Gordon ISBN 0-8213-0102-0. Stock No. WP 0529.An informative guide to the function Economic Liberalization and $3.and design of development finance Stabilization Policies in Interest Rate Management incompanies as they are set up in devel- Argentina, Chile, and Developing Countries: Theoryoping countries. Case histories high- Uruguay: Applications of the and Simulation Results forlight the differences among these com- Monetary Approach to the adSmlto eut opanies-their institutional structure, Blnetof paymets South Koreamanagement stvle, financial perfor- Balance of Payments Sweder van Wijnbergenmance, and other features. Looks at Edited by Nicolas Ardto Barletta,ee gethe problems of resource mobilization Mario I. Blejer, and Luis Landau deposit rates raise output and lowerand strategies to overcome them. Twenty-eight leading intemational inflation in the short run, and increaseStaff Working Paper No. 578. 1983. 84 economists and regional specialists re- growth through their favorable impactpages. view the salient characteristics of the on savings rates. It concludes that thisISBN 0-8223-0226>4. Stock No. WP 0578. monetary approach to the balance of theory depends heavilv on the as-S3. pavments, examine the vanations in sumption that portfolio shifts into timeits application, and evaluate its suc- deposits come out of unproductive as-Development Prospects of cesses and failures. Emphasizes the sets, providing less intermediationCapital Surplus Oil-Exporting empirical evidence and dvnamic as- than the banking svstem. Impact ofCountries: Iraq, Kuwait, Libya, pects and costs. Provides an important changes in time deposit rates on infla-Catriesa Arabia, U ibAEr examination of economic policies and tion, capital, capital accumulation andQzatar, Saudi Arabia, UAE their effects in a region that looms medium term growth are discussed,Rudolf Habliitzel large in current deliberations about in- and empirical relevance is demon-Staff Working Paper No. 483. 1981. 53 ternational indebtedness and finance. strated through simulation runs with apages (including statistzcal tables). June 1984. About 240 pages. macroeconomic model of South Korea.Stock No. WP 0483. S3. ISBN 0-8213-0305-8. 517.50 paperback. World Bank Staff Working Paper No. 593.
Developments in and Prospects Energy Prices, Substitution, ISBN 0-8213-0288-8. Stock No. WP 0593.for the External Debt of the and Optimal Borrowing in the $3Developing Countries: 1970-80 Short Run: An Analysis ofand Beyond Adjustment in Oil-Importing International Adjustment inNicholas C. Hope Developing Countries the 1980sStaff Working Paper No. 488. 1981. 70 Ricardo Martn and Marcelo Vijay Joshipages (including 2 annexes, references). Selowsky Staff Working Paper No. 485. 1982. 57Stock No. WP 0488. S3. Staff Working Paper No. 466. 1981. 77 pages.
pages (including footnotes, references). ISBN 0-8213-0062-8. Stock No. 0485. S3.Stock No. WP 0466. S3.
NEW NEWExchange Rate Adjustment
Domestic Resource under Generalized Currency Links between Taxes andMobilization in Pakistan: Floating: Comparative Analysis Economic Growth: SomeSelected Issues among Developing Countries Empirical EvidenceNizar Jetha, Shamshad Akhtar, Romeo M. Bautistaand M. Govinda Rao Staff Working Paper No. 436. 1980. 99 Keith MarsdenFouses on the relationship between pages (including appendix). Reviews the experience with growthtaxation and the three main compo- Stock No. WP 0436. S3. and taxation in twentv developing andnents of savings. Emphasizes tax re- developed countries, spanning a wideformn with a view to raising additional A General Equilibrium spectrum of incomes. Do countriesrevenues and encouraging household Analysis of Foreign Exchange with lower taxes experience moreand business savings. Proposals for tax Shortages in a Developing rapid expansion of investment, pro-reform take account of equityvconsid- Economy ductivity, employment, and govern-erations and the need to keep tax-in- Kemal Dervis, Jaime de Melo, and sheds new light on this and other kev
resources to a minimum. Highlights Sherman Robinson questions especiallv relevant to devel-appropriate policies on current ex- Staff Working Paper No. 443. 1981. 32 opment economists. It also examinespenditures, subsidies, user charges, pages (including references). the mechanisms bv which fiscal poli-public enterprise pricing, self-financing Stock No. WP 0443. 53. cies mav affect growth rates.of investment bv public enterprises. Staff Working Paper No. 605. 1983. 48Includes three annexes that examine pages.direct taxes, indirect taxes, and tax Prices subject to change without notice ISBN 0-8213-0215-9. Stock No. WP 0605.changes in Pakistan's 1983/84 budget. and may vary by country. $3.
NEW The Policy Experience of Private Bank Lending toTwelve Less Developed Developing Countries
Municipal Accounting for Countries, 1973-1978 Richard O'BrienDeveloping Countries Bela Balassa Staff Working Paper No. 482. 1981. 60David C. Jones Staff Working Paper No. 449. 1981. 36 pages (including appendix, bibliography).This manual is based on British prac- pages (inc,'uding appendix). Stock No. WP 0482. S3.tices and terminology of municipal ac- Stock No. WP 0449. P3.counting, modified to suit the needs of Private Capital Flows toother countries, especiallv those lack- The Political Structure of the Developing Countries anding a core of appropriately trained ac- New Protectionism Their Determinations:countants. Provides the basic princi- Doulas R. Nelson Historical Perspective, Recentples of municipal accounting tor those g * v acnwith little or no bookkeeping experi- Staff Working Paper No. 471. 1981. 57 Experience, and Futureence and proceeds through successive pages (including references). Prospectslevels of difficulty to some of the most Stock No. WP 0471. 53. Alex Flemingadvanced concepts currently in use, Staff Working Paper No. 484. 1981. 41including the pooling of loans. An im- pages.portant feature is the multitude ofpractical applications and examples of NEW Stock No. WP 0484. 53.forms and records. Private Direct ForeignA joint publication of the Chartered Price Distortions and Growth Investment in DevelopingInstitute of Public Finance and Ac- in Developing Countries Countriescountanc and the World Bank. Ramgopal Agarwala K. Billerbeck and Y. YasugiJune 1984. About 900 pages. Sixteen informative tables trace the Staff Working Paper No. 348. 1979, 101
ISBN 0-8213-0350-3. Stock No. BK 0350. distortion in Prices of foreign exchange pages (including 2 annexes).S30. and other factors affecting the growth Stock No. WP 0348. 55.
of developing countries. Based on sta-The Nature of Credit Markets tistics frorn thirtv-one developingin Developing Countries: A countnes. NEWFramework for Policy Analvsis Staff Working Paper No. 575. 1983. 78Arvind Virmani pages. Savings Mobilization throughStaff Working Paper No. 524. 1982. 204 ISBN 0-8213-0242-6. Stock No. WP 0575. Social Securitv: The Case ofpages. 53. Chile, 1916-1977ISBN 0-8213-0019-9. Stock No WP 0524. Christine Wallich
S5. Pricing "Policy for Development Describes the savings mobilization po-The Newly Industrializing Manage:ment tential in Chile and in five Asian pro-Developing Countries after the Gerald MI. Meier grams. Some sort of social securityOil Crisis Presupposing no formal training in program functions in almost all devel-economics, it explains the essential oping countries. Programs are oftenBela Balassa elements of a price svstem, the func- costly, whether measured in relationStaff Working Paper No. 437. 1980. 57 dons of prices, the various poiicies to GNP, government expenditure,pages (including appendix). that a government might pursue in government revenue, or the wage bill.Stock No. WP 0437. S3. cases of market failure, and the princi- This paper compares the successful
ples of public pricing of goods and systems.Notes on the Analysis of services provided by government en- Staff Working Paper No. 553. 1983. 109Capital Flows to Developing terprises. ;It also provides the would-be pages.Nations and the "Recycling" practitioner with an appreciation of the ISBN 0-8213-0123-3. Stock No. WP 0553.underlying logical structure of cost-Problem benefit project appraisal. To give sub-Ralph C. Bryant stance to the applied and policv di Short-Run Macro-EconomicStaff Working Paper No. 476. 1981. 67 mensions, manv of the readings are A P ipages. drawn from the experience of develop- Adjustment Polices m SouthStock No. WP 0476. S3. ment praclitioners and relate to such Korea: A Quantitative Analysis
important sectors as agriculture, in- Sweder van WijnbergenNotes on the Mechanics of dustrv, power, urban services, foreign Staff Working Paper No. 510. 1981. 182Growth and Debt trade, and emplovment. The principles pages (including 3 appendixes).Benjamin B. King outlined are therefore relevant to a ISBN 0-8213-0000-8. Stock No. WP 0510.A Practical model to explore the ay host of development problems.
in which cpai- The Johns Hopkins University Press. 1983.in which capital inflow from abroad af- 2772 pages (including bibliography and in-fects economic growth. dex).The Johns Hopkins University Press, 1968. LC 82-716. ISBN 0-8018-2803-1, Stock69 pages (including 4 annexes). No. TH 2803, 535 hardcover; ISBN 0-LC 68-8701. ISBN 0-8018-0338-1, Stock 8018-2804-X, Stock No. JH 2804, 512.95 Prices subject to change without noticeNo. IH 0338. 55 paverback. paperback. and may vary by country.
State Finances in IndiaA three-volume set of papers that ex-plores a range of issues relating to thenature of intergovernmental fiscal rela- Th p suc f Wtions in India. The pnmary source for World DebtTablesVol. 1: Revenue Sharing in India medium- and long-term E , ,' c .Christine WallichViol. rI: India-Studies in State Fi- extemal debt of mnanynalnces developing countries. =Christine WallichVol. III: The Measurement of Tax Ef- Suhas Ketkar, Asia-Pacificfcrt of State Governments, 1973-1976 Economist and Vice President,Raja J. Chelliah and Narain Sinha Marine Midland Bank, N.A.Staff Working Paper No. 523. 1982. vol.1, 85 pages, vol. 1I, 186 pages, vol. 11i, 85pages. ScOften the only reliableISB1N 0-8213-0013-X. vol. I, Stock No..ir WVP 1523, $3, vol. II, Stock No. WP source of information for2523, $5, vol. Ili, Stock no. WP 3523, S3. countries for which data
is hard to come by... Used quantitatively formacroeconomnic detail as well as qualitatively in
Structural Adjustment Policies reports discussing the debt picture. I find thein Developing Economies projected servicing payments a strong feature.09Bela BalassaBelaf WorkingsPaper No. 464. 1981. 36 Jonathan Kayes, InternationalStaff Working Paper No. 464. 1982. 36 Economist, RepublicPages. National Bank of New YorkStock No. WP 0464. 53.
Structural Aspects of Turkish World Debt Tables, 1983-84 EditionInflation: 1950-1979 The World Bank's invaluable reference Also available for the first timeM. Ataman Aksov guide to the external debt of develop- SStaff Working Paper No. 540. 1982. 118 ing countries. Essential planning tool ummary Reportpages. for economists, bankers, countrv risk Debt and the DevelopingISBN 0-8213-0098-9. Stock No. WP 0540. analysts, financial consultants and all World Current Trends55. thos~e interested in the global system Wol:CretTnd
of trade and pavments. Provides data and Prospectson the external debt of 103 developing Includes an overview and summary ta-
Thailand: An Analysis of countries augmented bv information, bles from the 1983-84 edition.Structural and Non-Structural where available, on major economic 1984. 64 pages.Adjustments aggregates plus indicators used to ana-Ame Drud, Wafik Grais, and lyze debt and creditworthiness. Shows Stock No. BK 0319, $6.50.IDusan Vujovic statistical tables by country, including Companion computerized datafigures for extemnal public debt out-Staff Working Paper No. 513. 1982. 93 standing, commitments, disburse- basepages (including appendix). ments, service payments, and net bor- Includes all debt information given in.'SBN 0-8213-0023-7. Stock No. WP 0513. rowings. Reports on private the unabridged volume, and, where'$3. nonguaranteed debt of 19 countries. available, offers continuous historical
Gives aggregate position of 13 major series for 1970-82 and projected debt-borrowers-countries with disbursed service payments for 1983-92. Write for
Trends in Rural Savings and and outstanding medium- and long- sample purchase agreement.Private Capital Formation in term total debt in excess of $13.5 bil- (9-track, phase-encoded, recordingIndia lion at the end of 1982. Includes peri- densitv 1600 bpi)Raj Krishna and G.S. odic supplements as fresh data are re- Stock No. IB 0500, $5,000 (service bur-Raychaudhuri eaus for reselling to their clients); StockWorld Bank Staff Working Paper No. 382. 1984. 328 pages. No. IB 0667, $2,000 (banks and commer-1980. 43 pages (including 2 tables, 3 ap- Stock No. BK 0315 $75 (annual subscrip- cial corporations); Stock No. IB 0666, $500pendixes, references). tion) (universities and libraries).
Stock No. WP 0382. $3.
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