March 6, 2003	Thursday	Muharram 2, 1424

KARACHI, March 5: These are bad days for banks — and they fear worse are in store. The reason is this: the yield on treasury bills has fallen to a record low of 2 per cent from more than six per cent at the start of this fiscal year. The surplus liquidity is there — and it is going to grow as the country continues to get unusually high inflows of foreign exchange — and the central bank keeps the dollar in oxygen tent for the benefit of the exporters.

“The State Bank is benefiting the exporters at the cost of the financial sector,” says head of a major foreign bank. “The policy of keeping the dollar artificially high is taking its toll on the interest rates. The very survival of the banks are at stake,” he warns.

The warning — that reflects the feelings of many leading local and foreign bankers approached by Dawn — has come at a time when the State Bank has made a huge one percentage point cut in the weighted average yield on six-month treasury bills. The central bank had to cut the average yield from around 3.2 per cent to 2.1 per cent on Wednesday to drain out a targeted amount of Rs30 billion from the inter-bank market through sale of six-month T-bills.

This is the second biggest one-time cut in six-month T-bills rate within this fiscal year. Earlier on November 27 the central bank had lowered the yield from 6.3 per cent to 4.7 per cent. The average yield on benchmark six-month bills has so far recorded a big fall of 4.2 percentage points since the start of this fiscal year in July last. This rapid fall has served its purpose quite well — and banks have started making loans more speedily to the private sector than in the past. “But there is still much room — and a dire need — for increasing private sector credit to let the economy grow,” says a senior central banker. “The State Bank has sent this very signal through rapid cuts in T-bills rates.”

But the big 1.1 percentage point cut in T-bills rate made on Wednesday was not primarily aimed at strengthening this signal.

“The SBP had no option but to do this to mop up the targeted amount of excess liquidity from the market,” explains the central banker.

RECORD BIDS: The SBP had set the T-bills sale target at Rs30 billion but the banks came up with total bids worth about Rs104 billion at the face value. “Of course the major chunk of the bids was speculative in nature — and banks had priced their bids too low to ensure their acceptance,” says another SBP official. “That was how the weighted average yield fell.” Sources in brokerage houses said the participation in the T-bills auction was so huge that the total number of bids received rose to 155. Out of that the SBP accepted 14 bids worth Rs30 billion belonging to four banks. These were (i) Citibank (ii) Habib Bank (iii) Union Bank and (iv) American Express Bank.

RATE-CUT EXPECTATIONS: “I know more than half of all the bids submitted by the banks were not actually supported by any real excess liquidity available with them,” confessed treasurer of a local private bank. “But the reason why banks came up with more and more bids for T-bills — and at cheaper and cheaper rates — is that they are expecting the interest rates to go further down.”

This expectation stems from two things: (i) banks believe that the country will continue to receive huge inflows of foreign exchange that ultimately raise the rupee liquidity levels also and (ii) the SBP will continue to keep the dollar artificially high thus creating a situation where excess rupee liquidity will stay within the banking system.

CONSEQUENCES: “The consequences of the SBP policy of keeping the dollar stable have started showing up,” says treasurer of a foreign bank. “If they do not leave the exchange rates to the market forces the exporters will continue to sell future export proceeds...the importers will remain shy of buying dollars...and people abroad will keep sending money out of panic.” All this will only enable the SBP to defend the dollar thus benefiting the exporters.

But this will certainly force banks to cut down their deposit rates further to make room for lending rate cuts — and that will discourage saving and investment. Frequent and heavy slashing of T-bills rate cuts may also drive some banks towards panic lending with all its consequences — a possible buildup in their non-performing loans included. That is why, many bankers say, bad days seem far from over — and fear still the worse.

NEGATIVE RETURN: The weighted average return on the bank deposits has already fallen below the consumer inflation rate. At end-January all the weighted average deposit rates of all the banks combined stood at 3.21 per cent against CPI inflation of 3.53 per cent.

With the treasury bills yield falling rapidly and private sector credit growth now set to see some negative growth because of ongoing credit retirement the banks would certainly lower their deposit rate further while making any cut in lending rates. The frequent and huge cuts being made in T-bills rates may also drive some banks towards panic lending with all its consequences following — a possible buildup in non-performing loan portfolio included. How badly a further cut in deposit rates would hit the savers who are already receiving a below inflation rate of return needs no elaboration. And now serious would be the impact of any panic lending on the health of financial sector is also anybody’s guess.

WHAT TO DO: From the viewpoint of the central bank the answer to this question lies in the banks becoming more disciplined and start aggressive credit marketing instead of keep investing all surplus money in zero-risk T-bills. Central bankers say the banks also need to bring down their cost of financial intermediation to make room for lending rate cuts instead of lowering the rates of return on the deposits.

But bankers say there is not much room for increasing credit demand in the short term. They also say that lowering of the cost of financial intermediation — which is basically the case with state-run and large privatized banks — requires further job cuts that would take time.

“Increasing credit demand and bringing in more discipline in banking operations is a slow and gradual process,” said head of a big local bank. “This cannot be done overnight.”

All the banks combined had offered about Rs75 billion credit to the private sector in the first eight and a half months of this fiscal year i.e. between July 2002 upto mid-February 2003 against only Rs30 billion in the full fiscal year 2001/2002. “So you see there is not much room for any major increase in credit disbursement at least during this fiscal year as credit retirement has already started,” says the banker. The full fiscal year target set for credit disbursement by all the banks combined is Rs94 billion.