With modest honor and respect, I submit my internship report on “Inflation Effect on Credit Rate of Commercial Banks in Bangladesh”. Certified that this project report titled “Inflation Effect on Commercial Banks Lending Rate in Bangladesh” is the bona fide work of Raju Lenard Gomes, who conducted the research under my supervision. Lending is the main service that commercial banks provide to their customers, in other words, banks provide advances and loans to individuals, government and corporate organizations.
Commercial banks are the most important institutions for savings, mobilization and financial resource allocation, consequently these roles make them an important phenomenon in economic growth and development. This phenomenon is attributed to the decisive role of the commercial banks in the economy. This suggests that the volumes of bank loans may partly depend on the performance of commercial banks.
Although commercial banks' lending rates are determined by several factors beyond the control of the Central Bank of Bangladesh, the Monetary Policy Committee, which is the Central Bank's central policy body, notes that structural changes in the deposit and credit markets, including the introduction of development banking products, can play a significant role in influencing a downward trend in commercial banks' lending rates. Economic Watch states that in most developed economies, such as the United States, commercial banks keep interest rates on loans equal to the rate of inflation. In Germany, the lending rate is a key factor in the lending policy of commercial banks, so that when the lending volume of commercial banks decreases, showing a certain correlation between bank loans and interest rates, the profitability of commercial banks on lending is suppressed.
General Objective
Furthermore, the performance of the banking system is important to savers, owners, potential investors and policymakers, as banks are the effective executors of government monetary policy. The Central Bank of Bangladesh has played an important role in formulating and implementing monetary policies aimed at achieving and maintaining low inflation as one of its key principles. Since its inception in 1971, the Central Bank of Bangladesh has used a monetary targeting framework to pursue its inflation target.
Monetary policy strategy has been and will continue to be based on the assumption that money matters, that the behavior of monetary aggregates has a major impact on the performance of the economy, especially inflation. Commercial banks in Bangladesh have experienced fluctuating loans from both retail and corporate customers, so the Bank is no exception to this phenomenon, but there is no known empirical research showing whether the fluctuations could be due to high interest rates, or are caused by inflationary forces. . However, when inflation rises, the financial institutions that issue debt instruments should entice investors with higher interest rates.
Research on the determinants of interest rates 6 identified interest rates as a factor determining credit volumes in Colombia, while Zaremba's (2008) study on “Bank Loans, Expenditure Components and Inflation in South Africa” confirms this claim and states that there is a correlation exists between bank loans and interest rates.
Definition of Terms .1 Inflation
Interest rate/Lending rate
Lending volumes
Investment
Bank
LITERATURE REVIEW
- Introduction
- Impact of Inflation on Bank Lending Rates
- Inflation
- Commercial Banks’ Base Lending Rate
- Relationship between inflation, Base Lending Rate and Commercial Bank Lending Volumes
- Commercial Bank Lending Volumes versus Inflation
- Commercial Bank Lending Volumes versus Base Lending Rates
- Commercial Bank Lending Volumes versus both Inflation and Lending Rate
- Relationship between Inflation and Loan Default Rate .1 Non-Performing Loans
- Loan Default Rate
This suggests that interest rates and inflation are correlated and therefore have a close relationship between the two. The study on “the choice of an optimal monetary policy instrument for Bangladesh” found that interest rates rose when inflation was high and fell when inflation was low. In this case, inflation can be stabilized by adjusting interest rates in response to output and inflation.
Gupta, (2010) who conducted a study on the impact of inflation on home loans, notes that inflation is a major cause of fluctuating interest rates and increase in home loan interest rates. Nicholas (2015) further notes that inflation reduces the purchasing power of money, inflation and the expectation that it will continue causes lenders to demand higher interest rates on loans. Nicholas (2017) further notes that inflation reduces the purchasing power of money, inflation and the expectation that it will continue causes lenders to demand higher interest rates on loans.
He further notes that a positive correlation between interest rates and inflation does not necessarily mean an increase in interest rates or that a high interest rate causes greater inflation. Frederick (2018) in the study on "Central Banking after the crisis in Chile" observes that low interest rates increase net interest margins leading to increases in the value of financial firms. Further quoting from (Bernanke 1999) showed that low interest rates can increase collateral values, which in turn enables increased lending volumes.
In the same vein, Barajas' (1999) study on the determinants of interest rates identified interest rates as a factor determining loan volumes in Colombia. Therefore, changes in interest rates can have negative effects on loan volumes. Njagi (2012) presenting the relationship between interest rates and money supply confirms that the increase in interest rates is used by the Central Bank of Bangladesh to restrict credit and money supply, thereby curbing inflation.
The results of the study showed that interest rates affect inflation in all countries. Rittenberg (1991) has identical findings that high interest rates can be harmful to investment and growth. High interest rates do not contribute to increasing the profitability of banks in the long term. 2004) believe that high rates are responsible for higher defaults and declining bank profits.
To restore its financial position, the country resorts to high interest rates and the cycle is complete.
RESEARCH METHODOLOGY
- Research Design
- Sampling Technique
- Data Collection Methods
- Data Analysis Methods
- Relationship between annual inflation rate and Bangladesh Commercial Banks base lending rate from the year 2011 to 2020
- Relationship between annual Bangladesh Commercial Banks New lending volumes and both inflation rate and base lending rate from 2011 to 2020
- Relationship between BCB annual loan default volumes and inflation rate from 2011 to 2020
The known variable is called the independent variable(s) which include the lending rates, lending volumes and the loan default rate. The unknown variable that is estimated depending on the objective sought from the research questions, that is the first one was commercial banks lending rate, the second is the lending volume and third is the loan default rate, a scatter diagram is drawn for the case of regression- analysis, the regression line is put in place by visually fitting the lines between data points, while the correlation analysis was also used to describe that the degree of one variable is linearly related to the other. Coefficient of determination was also used to give the magnitude, or the strength of the associations between two variables X and Y.
A sample coefficient of determination was developed based on the relationship between two types of variations, which is a sum of a group of quadratic variations. Graphs were used to illustrate the trends to determine the effect of inflation on the base rate. Annual inflation for the period was reduced relative to the banks' base rates.
A linear relationship was established between the dependent variable in this case, the lending rate of commercial banks, and the independent variable, which is inflation. A simple regression was used for the regression analysis and conclusions were drawn based on the regression analysis. To access the effect of inflation rate and prime lending rate on the annual lending volume charts of Bangladesh Commercial Banks were used to illustrate the trends.
The annual inflation rate and the base loan rate were first compared separately with the annual figure for the new credit volumes for the period between and the linear relationship between the dependent variables, in this case, the new loan volumes and the independent variables, in this case, the generated inflation and the base loan rate. Simple regression was used for the regression analysis and conclusions were drawn based on the regression analysis. To determine the effect of inflation on the annual loan default rate, graphs were used to illustrate the trend.
The annual inflation rates for the period were regressed against BCB's annual default rate. The linear relationship between the dependent variable in this case, the annual default rate of commercial banks and the independent variables which is inflation was generated.
RESULTS AND FINDINGS
- Bangladesh Commercial Base Lending Rate 2011-2020
- Trends in Inflation rate
- Regression Analysis of Inflation Rates on Base lending Rates
- Relationship between New lending Volumes, Base Lending Rates and Inflation Rates
- Analysis of Base Lending Rates and Inflation Rates against New lending Volumes
- Relationship between Inflation rate and Loan Default Rate
The study further suggests that the rate of inflation has little impact on prime lending rates as inflation rates increase; moderate effect on prime lending rates. There are other major factors that contribute to the increase or decrease in prime lending rates that the study did not investigate, but are lumped together as an error term. The study sought to investigate the effects of inflation and prime lending rates on the volume of new loans.
The study reveals that new loans and advances have steadily grown over the past ten years from 33.6 million BDT in the year 2011 to 204.6 million in the year 2020. The study shows in Figure 4.4 that both cooperative and retail loan volumes on ' an increasing trend in the last ten years. This suggests that, despite other factors such as inflation and changes in interest rates, lending volumes are increasing.
The trend of changes in the rate of loan defaults has been observed from data obtained from the annual financial statements of the Central Bank of Bangladesh. Loan default volume trends fluctuated throughout the period, reflecting an upward trend between 2016 and 2017. Loan defaults in commercial institutions can have a negative effect on the bank's cash reserves.
There are several factors that can contribute to loan defaults. Important ones include inflation, high interest rates, monetary policy, general changes in the money market and unfavorable international trade. The effects of changes in inflation and key interest rates on loan defaults have been assessed and the results are presented. The finding points to a weak but positive relationship between inflation and key lending rates.
The result also indicates a strong positive relationship between the base lending rate and new credit volume, and a weak relationship between the level of inflation and new credit volume, with the two variables, considered separately, but taken together, having a moderate effect on new credit volume of the banks.
LOAN DEFAULT VOLUME
Recommendations and Conclusions
Conclusion
Base lending Rates VS Inflation
Lending volumes VS Inflation
Loan Defaulting Volumes VS Inflation Rates
Recommendations
