A benchmark rate should be put in place in order to evaluate the pricing of various products of the financial market for better management of interest rate risks, analysts said yesterday.
There is no ideal rate in the market to judge the variable price of financial products set by banks, said Prof Shah Md Ahsan Habib, director of Bangladesh Institute of Bank Management (BIBM).
A market-based rate will eliminate the fluctuation risk of interest rate for banks, he said.
He spoke while presenting a research paper titled “Benefits and potential of interest rate hedging: Bangladesh perspective”, at a workshop at the BIBM auditorium in Dhaka.
He stressed the need for introducing new derivative products for risk management of interest rate.
Habib gave the example of the swap, a derivative product that is used in case of taking loans in foreign currency.
An interest rate swap is an additional contract between two parties that allows them to exchange floating rates for a more favourable fixed rate, he said.
According to the research paper, the banking industry in Bangladesh mostly follows the segmented interested rate. Most deposit rates are fixed in nature. In case of lending, the rate is conditionally set, meaning it changes with the change of market interest rate.
Like other countries, these rates are not tagged with the market-driven interest rate such as the London Interbank Offered Rate (LIBOR) or any government securities, the research paper said.
The paper noted that any increase in the LIBOR will definitely create interest rate risk for Bangladeshi borrowers.
The LIBOR has become important for Bangladesh after the private sector started borrowing significantly from foreign sources in 2013 when the global benchmark rate was at its lowest.
But the LIBOR has started increasing which will definitely affect borrowers in terms of higher interest payments. In absence of derivative instruments, borrowers are exposed to interest rate risk, according to the research report.
Interest rate risk is the potential impact on a bank's net interest income and the market value of equity because of adverse movements in rates. It also widely affects bank's cash-flows.
Interest rate volatility in the financial market is high, said SK Sur Chowdhury, banking reform adviser of Bangladesh Bank.
He said developing a derivative market would give commercial banks an opportunity to manage their risk exposure and generate revenue.
The central bank should take initiatives to develop a derivative product for the financial market, said Md Ali Hossain Prodhania, managing director of Bangladesh Krishi Bank.
Helal Ahmed Chowdhury, a supernumerary professor of the BIBM, said import expenditure witnessed a sharp rise pushing banks towards a liquidity crunch. Import in the unproductive sector should be stopped to cool down the dollar market, he suggested.