Should banks invest in govt securities?

There is a growing debate in Bangladesh over whether banks' heavy investment in treasury securities, instead of lending to the private sector, reflects a failure of the sector. After all, we have long understood that banks are supposed to lend to businesses, entrepreneurs and individuals to help drive economic growth. With private sector credit growth dwindling at 7.5 percent, some are calling for penalties or restrictions on banks that invest in treasury securities.

But the reality is far more nuanced. In fact, banks allocating capital to government securities under current conditions is entirely rational and even desirable, given the broader economic, financial and regulatory context that shapes their decisions.

The primary role of monetary policy is to regulate aggregate demand by influencing the cost and availability of credit in the economy. When the Bangladesh Bank raises policy rates, currently at 10 percent, its goal is to curb excessive credit expansion, limit borrowing and cool inflationary pressures.

If banks were still expanding credit rapidly at these high rates, that would actually indicate a failure of monetary policy, as the intended tightening would not be taking effect. Instead, the slowdown in private sector credit growth confirms that tighter monetary conditions are working as intended.

Banks are doing what monetary policy has encouraged them to do, which is to be more cautious in their lending decisions. Banks, like any profit-driven institution, respond to risk and return trade-offs. With government securities offering attractive yields, such as 91-day bills yielding around 12 percent, it is economically rational for banks to allocate more of their portfolios to these instruments. This is particularly true in a high-risk macroeconomic environment where private borrowers may be struggling with profitability or creditworthiness.

Banks have a duty to protect their depositors' funds and maintain financial stability. If policymakers want to change this behaviour, the solution lies in adjusting incentives, not in criticising banks for playing by the current rules. This could mean lowering policy interest rates to reduce the cost of government borrowing. It could also involve cutting fiscal deficits to lessen the government's borrowing needs and reduce bond issuance, making government securities less dominant in the financial system.

Another overlooked factor is capital adequacy. Following the 2008 global financial crisis, banks in North America and Europe sharply reduced lending to strengthen their capital buffers and protect themselves against future shocks. Bangladesh's banking sector is facing a similar capital shortfall today, with many banks under pressure to improve balance sheet health and meet regulatory requirements.

Government securities offer a low-risk, capital-efficient investment option that helps stabilise bank portfolios without adding to credit risk. In this context, investing in treasuries is not a sign of negligence or complacency. It is a prudent and responsible move under conditions of regulatory and financial stress.

This pattern of behaviour is by no means unique to Bangladesh. It is a common outcome in countries that run tight monetary policies to control inflation, while maintaining liberal fiscal policies that require sustained government borrowing. In many economies, particularly following a rise in bad loans or a financial crisis, banks have shifted their portfolios towards government securities in much the same way.

Banks investing in government securities is not inherently wrong, inefficient or harmful. It is a rational response to high policy interest rates, elevated government borrowing, weak private sector demand and ongoing capital adequacy issues. Rather than viewing this as a structural flaw of the banking sector, it should be seen as a predictable outcome of current macroeconomic policies. The path forward lies in coordinated monetary and fiscal reforms that align incentives and create conditions for sustainable credit growth. Blaming banks for responding logically to the policy environment will not address the underlying challenges.

The writer is the president of CFA Society Bangladesh and co-founder of EDGE AMC Limited.