BB Raises Policy Rate Signaling More Contractionary Stances

In a recent development in monetary policy, Bangladesh Bank (BB) raised the policy rate (repo rate) by 75 basis points to 7.25%.

Currently, BB has interest rate corridor in place which  is a +/- 200 bps symmetric corridor consisting of a standing lending facility (SLF) rate and a standing deposit facility (SDF) rate.

With the change in policy rate, now, the upper limit on standing lending facility (SLF) rate stands at 9.25% up from 8.50% and the lower limit on standing deposit facility (SDF) rate stands at 5.25% up from 4.50%.

This means that banks and NBFIs can borrow from BB through SLF at interest rates ranging from 7.25-9.25% and these institutions can deposit surplus cash with BB at an interest rate of 5.25%. This interest rate corridor implies that short term interbank call money rate remains around the policy rate.

Implications on Deposit Rate and Lending Rate: Even though raising policy rate makes borrowing through repo costlier, it doesn’t have direct implication on deposit rate and lending rate as lending rate cap is currently determined by six month moving average of 182-days treasury bill rate which is called SMART rate. Using the SMART rate as reference rate, banks and NBFIs can charge margin of up to 3.0% and 5.0% respectively. When banks can find scope for increasing their lending rate, they will also have the room for raising deposit rate.

So, treasury rate has more direct implication on deposit and lending rate.

Signaling Effect: It’s true that policy rate doesn’t have direct effect on deposit and lending rate, however, the change in policy rate can exert signaling effect in the overall interest rate environment.

BB has already reduced its devolvement (BB’s purchase of treasury securities) level to zero in the last two months which have pushed up the treasury rates.

Meanwhile, according to daily newspapers, BB is devising more measures to tackle inflation. The central bank is also making some changes in how monetary policy committee is formed. At present, the central bank has a monetary policy committee constituted by only internal officials headed by the governor. Now it will reconstruct the committee adding two or three members from outside the Bangladesh Bank following the Indian model. The committee will be approved by the board of the Bangladesh Bank. This will add new dimension in formulating monetary policy.