No easy way out to rescue banks from repayment trap

In recent months, the Bangladesh banking sector has witnessed an extraordinary surge in cash flow into banks, offering a respite amid a backdrop of a stringent monetary policy aimed at tackling rising inflation.

This phenomenon, however, is not without its challenges, as the surge in liquidity raises concerns about its potential impact on inflation and the overall stability of the financial system.

According to Bangladesh Bank (BB) statistics, the central bank has provided significant liquidity support to commercial banks, with the volume reaching Tk 3.45 trillion in November and already surpassing Tk 3.30 trillion in December 2023.

While this liquidity injection has been vital for banks grappling with a liquidity crunch, economists caution that it may exacerbate inflationary pressures.

The rising interbank call-money rate, reaching 9.16% on December 27, signals increased costs for banks to borrow from interbank markets. Economists argue that indiscriminate funding of all banks could further burden the public with heightened inflationary pressures.

Striking a balance between providing necessary liquidity support and avoiding inflationary repercussions is crucial for sustaining economic stability.

The primary reason behind the surge in liquidity demands is the banking sector’s struggle to cope with liquidity shortfalls due to the extensive purchase of high-priced US dollars and supporting the government’s domestic bank borrowing to address budgetary deficits.

The excess liquidity in commercial banks has dwindled, dropping from Tk 1.81 trillion in July to Tk 1.58 trillion in October.

The BB’s decision to meet the escalating fund requirements from commercial banks, despite concerns, is understandable given the current stress in the banking sector.

The fear of severe liquidity crises and a potential spike in the call-money rate necessitates continued cash infusions. However, a nuanced approach is needed to prevent the unintended consequences of inflation.

Instead of a blanket approach, a more strategic allocation of credit support to banks in dire need will help stabilize their financial health without contributing to inflationary pressures.

As Bangladesh braces for the post-parliamentary election period, the demand for credit is expected to surge, further tightening the liquidity situation.

To preclude potential challenges, the banking regulator must proactively implement policies that promote market liquidity and ensure a judicious distribution of support to banks.