Will CRR cuts bring down lending rate?

The decision to reduce the Cash Reserve Ratio (CRR) by one percentage point constitutes quantitative easing of monetary policy. A key question is: will it achieve the stated objective of bringing down the bank lending rates back to single digits. There are good reasons to have some doubts.

First, there is slow pass-through of policy changes to bank interest rates. The extent of pass-through to the deposit rate is larger than that to the lending rate. Second, there is evidence of asymmetric adjustment to monetary policy: deposit rates do not adjust upwards in response to monetary tightening, but do adjust downwards to loosening; and, as experienced most recently when the Advance Deposit Ratio (ADR) was raised, the lending rate adjusts more quickly to monetary tightening than to loosening. 

On these assumptions, we can expect the deposit rate to fall quicker and to a larger extent than the lending rates in response to the reduction in CRR.

This decision also raises the question of the consistency of monetary policy decisions. Just two months ago, the Bangladesh Bank announced reduction of ADR, allowing the banks up to December 2018 to comply with the tighter ADR of 83.5 percent from the prevailing 85 percent. The reduction of CRR is a measure in the opposite direction.

Last but not the least, is it going to fix the underlying causes of liquidity shortfall that some banks are facing? Most analysts agree that the underlying cause is deficit in corporate governance in these banks, particularly in the areas of loan risk management and collection of non-performing loans. Banks who have done badly in these areas are the ones having the most difficulty in complying with the CRR. The CRR reduction will help them avoid the penalties for noncompliance, but it does little to incentivise improvements in corporate governance.

The writer is lead economist at the World Bank's Dhaka office who gave the write-up to The Daily Star as a comment.