November 24, 2001	Saturday	Ramazan 8, 1422

KARACHI, Nov 23: The State Bank wants banks to narrow the gap between lending and deposit rates. In more clear terms, it wants them to make more cuts in their lending rates than in the deposit rates. But at the same time, senior SBP officials realize that the banks could not do this, until they come out of the liquidity crisis that hit them after the September 11.

The newly-appointed deputy governor of SBP Tawfiq A. Husain met heads and treasurers of nine leading local and foreign banks on Friday and discussed with them the nitty-gritty of the issue.

The banks whose top men attended the meeting were (i) National Bank (ii) Habib Bank (iii) United Bank (iv) Muslim Commercial Bank (v) Metropolitan Bank (vi) Bank Alfalah (vii) Citi Bank (viii) Standard Chartered ANZ Grindlays Bank and (ix) ABN Amro Bank.

Sources close to the meeting said the bankers told the deputy governor that the inter-bank market is so short of liquidity that any attempt to cut deposit rates would deepen the crisis. Most of the bankers said they could not think of reducing interest rates without making a cut in the deposit rates. The sources said the SBP deputy governor said he realized this point.

At present there is a big gap of nine per cent between the weighted average lending and deposit rates of all the banks with the lending rate at 14 per cent and deposit rate at 5 per cent.

The fact that the gap has been on the rise for the past two fiscal years despite all banking sector reforms puts a question mark on the utility of these reforms. Though the gap has lately started shrinking slowly the State Bank wants to make it sure that the trend goes on. (In July the gap was 9.43 per cent that came down to 9.13 per cent the following month). The SBP rightly expects the banks to reduce their maximum lending rates because since July this year, it has so far reduced its own discount rate by four per cent to 10 per cent.

But the participants of the meeting were of the opinion that since the start of the fiscal year in July, the inter-bank market had been too short of liquidity to enable banks to cut lending rates. They said the liquidity crisis deepened further after the September 11 attack on New York and Washington and retaliatory US attack on Kabul. But some of them said banks would make modest cuts in their lending rates early next year when part of the liquidity, now out of the banking system, would return.

They said for the past few weeks an average of Rs10 billion discounting had been taking place every day. Even, on Friday the market saw a huge discounting of Rs14.5 billion.

Bankers say one of the things that had drained out liquidity from the banking system is that cash holding has risen sharply since September 11.

In September-October, the currency in circulation shot up by more than Rs30 billion: Bankers say now the figure has even crossed the mark of Rs40 billion.

But liquidity crisis is a temporary phenomenon. There are some other more permanent things that make it difficult for the banks to minimize the gap between lending and deposit rates. These are:

(i) High interest rate still being paid on the national saving schemes.

(ii) High tax rate on the banks income.

(iii) Huge drag of non-performing loans; and

(iv) High cost of financial intermediation.

The sources said bankers were of the opinion that the government should cut the interest rate on the national saving schemes, if it wants the banks to cut their lending rates.

They also pointed out that a high tax rate of 58 per cent on banks profit leave little money with banks thus limiting their ability to cut lending rates while keeping deposit rates intact.

The government has cut the tax rate to 50 per cent but the new rate would be effective from next fiscal year.

Bankers also informed the SBP deputy governor that a huge drag of non-performing loans also made it difficult for the banks to do this. Bankers also admitted that the banking sector as such had failed to cut the cost of financial intermediation to the desired level though private local and foreign banks had done this better than the state-run banks.

The sources said the SBP deputy governor told the banks that the central bank would continue to inject funds into the inter-bank market to ease off the liquidity crisis. But at the same time, he asked the bankers to manage cash flows more efficiently.