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Interest rates on government securities have dropped sharply since early February as the banking sector, flush with excess liquidity, faces weak private sector loan demand, signalling a likely decline in lending rates.

The Bangladesh Bank sees the decline in government securities’ interest rates as a sign of economic recovery after a soft landing of macroeconomic indicators, with the expected drop in lending rates likely to curb inflation, reduce financing costs and, eventually, stimulate investment demand.

Yields on government securities have dropped nearly two percentage points since December, falling to just over 10% in February.

In the latest auction for a five-year bond held in the second week of February, the Bangladesh Bank aimed to raise Tk4,000 crore for the government at an interest rate of 12.09%. However, banks submitted bids totaling Tk22,389 crore – more than five times the government’s target – prompting the central bank to reduce the interest rate to 10.47%.

As the Bangladesh Bank accepted only the notified amount of Tk4,000 crore from the auction, banks were left with Tk18,389 crore in excess liquidity that day.

Similarly, in the 91-day bill auction held on 16 February, the Bangladesh Bank aimed to raise Tk3,500 crore at a yield of 10.54%, but banks submitted bids totalling Tk8,072 crore – more than double the amount. As a result, the central bank reduced the cutoff rate to 10.35%.

A senior Bangladesh Bank executive, directly involved in monitoring monetary policy developments, told TBS that the sharp decline in government securities’ interest rates signals the need to revise the policy rate downward.

Speaking on condition of anonymity, the official explained that interest rates on government securities have started to slow down since December due to weak private sector credit demand. Banks are also opting to invest in government securities rather than lend to the private sector amid political uncertainty.

In this context, the central bank kept the policy rate unchanged at 10% in its latest monetary policy for the second half of FY25 as the lending rate rose to the expected level above 11%. However, the Bangladesh Bank will likely need to lower the policy rate soon due to the sharp drop in government securities’ interest rates since February, the official added.

During the monetary policy announcement event on 10 February, Bangladesh Bank Governor Ahsan H Mansur hinted at a possible reduction in the policy rate in the second half of this fiscal year, in line with global trends.

Explaining the impact of falling interest rates on government securities, the central bank executive said that it would help curb inflation by reducing financing costs for both the government and the private sector.

As banks face lower yields on government securities, they are likely to shift towards financing the private sector by lowering lending rates. This reduction in rates will spur investment demand, marking the beginning of economic recovery, said the central bank executive.

The International Monetary Fund (IMF) in its World Economic Outlook January 2025 update projects that monetary policy rates of major central banks will continue to decline.

Referring to Outlook projections, the Bangladesh Bank executive stated that energy commodity prices are expected to decline, which will help reduce inflation in the domestic market. As a result, the Bangladesh Bank will not need to hike the policy rate further in the near future.

Banks’ need for liquidity support from BB declines

The need for liquidity support from the Bangladesh Bank declined significantly as many weak banks focused on deposit gathering rather than lending activities. For instance, the central bank reconstituted the boards of 11 weak banks after the ousting of Sheikh Hasina on 5 August last year. Among these, most large banks have already seen improvements in their liquidity positions due to a recovery in deposit growth.

Md Mehmood Husain, chairman of IFIC Bank PLC, one of the 11 banks, told TBS that they stopped lending and launched an extensive deposit campaign shortly after the board reshuffle. The bank saw significant deposit growth in recent months, which helped it overcome the liquidity crisis.

“We are not taking any liquidity support from the central bank and resumed lending on a limited scale from February due to strong deposit inflows,” he said.

The central bank governor, during the recent monetary policy announcement event, also said the liquidity positions of two large banks, including Islami Bank and United Commercial Bank PLC, which are on the list of 11 weak banks, have improved significantly. They are now operating independently without requiring liquidity support from the central bank.

The Bangladesh Bank has guaranteed Tk11,100 crore through its credit guarantee scheme to facilitate interbank transactions and assist banks facing liquidity constraints. By December last year, Tk7,350 crore had been utilised under this scheme.

Additionally, special liquidity support totalling Tk23,500 crore was allocated to banks dealing with operational liquidity challenges, with nearly Tk17,000 crore already used, according to Bangladesh Bank data.

Banks’ excess liquid assets increased by Tk19,000 crore over six months, reaching Tk2.15 lakh crore by the end of December 2024.