Corporate borrowings: banks reluctant to lower mark-up
By Jawaid Bokhari
DESPITE moral susasion by the State Bank and the ministry of finance, banks are reluctant to lower corporate borrowing costs in line with the cut in discount rate.
The SPB figures indicate that the weighted average lending rate for all groups of banks has come down by only 32 basis points to 14.10 per cent since July 2001. The discount rate has been cut by 300 basis points since September 1, 2001.
To quote financial analysts, a stronger exchange rate has left room for the central bank to stimulate the economy through cut in discount rates.
A group-wise breakdown, to quote Taurus Securities, indicates that the largest reduction is in foreign banks’ weighted average lending rates by 151 basis points. During this period, the weighted average landing rates increased by 61 and 14 points respectively for nationalised and privatized local banks.
As the problems of low investment, stagnant economy and rising poverty begin to haunt the government in an election year, it is focusing more on the issue and is advising the banks to reduce the lending rates.
Corporates have been demanding cheaper money to finance investment and face global competition. In Japan, the lending rate is one per cent and multinationals here borrow at 12 per cent. The interest rate goes up with risks linked to weaker companies, ranging from 14 to 16 per cent or more. Small business pay as much as 22 per cent.
The nationalized commercial banks, on the other hand, have been reducing the deposit rates and pay below 5 per cent on PLS accounts. They also do not accept deposits beyond one year. The focus is on balance-sheet and a reform agenda for privatization.
Economist Abid Naqvi, managing director, Taurus Securities says: “ Whereas firms in general will benefit from the rate cuts, interest rates are likely to squeeze commercial banks’ profitability.”
In most developed economies, lower interest rates are a stimulant to financial sector profitability as credit demand and volumes increase. In case of Pakistan, however the credit demand is seasonal and not as responsive to interest rate movement. Thus lower interest rates without a corresponding increase in credit means a squeeze in interest income in banks. Moreover, on account of generally lower trading activity projected for the current year, banks’ commission and trade-related income, will also be negatively affected.
The interest of the international community and foreign investors has been revived and the opportunity for economic development should not be missed, says Mr. Latif E. Jamal, chairman Hussein Industries, a company that runs its business exclusively on exports to the USA and Europe. He stresses that “growth must come first”, and, “lending rates must come down.’’
On the other hand, the nationalized commercial banks have been reducing the deposit rates and pay below five per cent on PLS account.
With the deregulation of the banking system, directives cannot be issued by the State Bank, says an SBP official, though the central bank does enjoy leverages to ultimately persuade the banks to move in the direction indicated by it.
To intensify moral suasion, the State Bank Governor, Dr. Ishrat Husain, organized an inter-action recently between businessmen and bankers at a meeting held by the Federation of Pakistan Chambers of Commerce and Industry.
The financial analysts see another dimension of the lending rate issue. They say that credit demand is a seasonal phenomenon; peaking during October-March period is in line with the agricultural production cycle. Even if banks lower the interest rates in the second half of the financial year, the lower interest rates may not be too effective in increasing credit demand and reducing the private sector’s borrowing costs.
The President of the Pakistan Banks Association (PBA), Zubyr Soomro, told Dawn the impact of the discount rate on the lending rate is not direct. The best indicator of liquidity is the average overnight Repo rate, the effective rate at which banks lend each other. The reduction in Repo rate has been marginal.
He argues: there are 2-3 themes why our lending rates are not coming down so much. We don’t have an efficient inter-bank market as you have in other countries. If bank “A” has surplus, bank “B” is short of funds, the money moves from “A” to “B” with clean lending, overnight lending rate with no problems.
In Pakistan, still the inter-banking lending is on the basis of secured lending. That you have securities to give me to keep, before I give you money. That is inefficient way of getting funds. What happens is that you have some banks that are sitting with large liquidity. And they don’t want to lend more either because they feel that they have enough good customers or they prefer to put their money in government treasury bills, even though rates have come down.
They don’t want to take a risk. And there are other banks which need money which are pushing up the deposit rates, so on and so forth. And the money does not move smoothly in the system. This is one of the things we need to develop.
The impact of the lending discount rate on lending rate is not direct. The discount window is one of the ways by which the banks finance themselves. It is a small way, which you use when you have problems of some sort. It is in exceptional situation that you go to the State Bank. Banks typically fund themselves from many other sources, corporate deposits, consumer deposits, savings accounts and current accounts and so many other ways. And in those areas you have not seen 5 per cent reduction in rates. Those are the areas that will reflect market liquidity more accurately. And it is the change in market liquidity that would affect the lending rate directly.
And Zubyr Soomro maintains that the best indicator of liquidity is the average overnight Repo rate.This is the effective rate at which banks lend each other through the process of the government securities. We will lend to the XYZ bank and they would deposit government securities of an equivalent amount. If you see how the rate has moved, there was no such reduction of 5 per cent. The reduction has been marginal. The overall liquidity in the system has not improved to the extent that five percent cut would apply.That is another aspect of the issue.
Having said all this, the PBA president points out that lending rates have come down. The weighted average lending rate has come down by 2 per cent when the rates are compared for January 2000 and January 2001 which is nowhere five per cent people look for or expect. It is a reduction and a good reduction.
Dwelling upon another aspect that comes into this(lending rate) is, what he describes the role of the large nationalized commercial banks(NCBs). Zubyr observes: the NCBs have the lowest cost of funds generally seen from the press statements made by the heads of the big banks. They say interest rate reduction is not easy to come by even though they have the lowest cost of funds. So it is an interesting phenomenon that you see in the market.
The big banks which have more than a thousand branches that can attract cheap money, find it difficult to cut lending rates. Foreign banks which do not have the network and therefore access to cheap money, are be able to reduce the lending rate. They (NCBs) argue and their argument has some merit that these banks are carrying 2-3 burdens which have been bequeathed to them by successive governments for many years.
They have a heavy operating cost base, too many people and too many branches. We have seen progress on both but the problems have not been fully resolved.
The second issue is that if you have a large stock of bad debts, it means heavy carrying costs, 2, 2.5-3 per cent; they just carry the debt burden portfolio on which they are earning nothing but they are still paying the depositors.
And yet the third issue is that the government, primarily, the CBR, which owes a lot of dues to banks, taken from these banks which are now refundable. Refunds taken for ever to come. There are signals that formulae have been worked out to resolve these problems; otherwise, there would be an impediment to the privatization process.
These three factors affect the big network banks,pushing up, not their cost of funds but other operating costs because of bad debts, because of networking and staffing and because of dues from the government, primarily taxes. And the three things added together, and you put them on top of the low cost funds, it makes them (NCBs) almost uncompetitive. And these are the things on which progress has to be made.
