KARACHI, May 31: A massive growth in bank credit to the private sector is raising pertinent questions as to where these funds are being deployed and how it would impact on the banking system.

“Estimates of actual usage of financing by the private sector suggest that there is a case of heightened monitoring of credit flows in the economy by the State Bank,” says a research report of a foreign bank.

If sustained through the end of current fiscal, the report reckons that credit off-take by private sector may outpace nominal GDP growth rate (stipulated at 8.5 per cent) by a wide margin. On this count, the outstanding stock of bank credit on March 31, 2003 amounted to 22.7 per cent of the GDP and against historical (1990-2002) average of 21.7 per cent.

Economists at the ABN-AMRO say that “it may be premature to raise alarm at the pace of credit growth” but “it has to be borne in mind that excessive credit growth-defined at sustained increase over and above the growth in nominal GDP is a leading contributor to banking system crises worldwide.”

Apart from the normal channels which absorb credit, there is low interest rate-specific demand for finance.

As the big corporations have access to the cheapest credit, says a banker, many companies are retiring their old expensive debts and taking new loans available at interest rate of 0.5-0.75 per cent above the treasury bills. Hence the financial health and profits of corporates is improving. For these companies, the interest rate varies from 2.5-3 per cent in a floating T-bills rate regime. With excess liquidity and fiercely competitive environment, the banks have poor bargaining power against big borrowers. The situation has been made worse by pressure from the State Bank to lend money in dollars to exporters instead of the rupee, says a senior banker, had pressed to improve profit margins.

“A not-insignificant amount of credit has been used to finance arbitrage opportunities — mainly investments in high yielding but secure National Saving Schemes,” says a financial analyst at a foreign bank.

Market reports indicate that there are quite a seizable number of borrowers who secure cheap credit to invest in Special Savings Certificate (SSC) carrying an interest rate of 8.5 per cent. Obtaining loans at 4.75-5.5 per cent interest, they earn a cool spread of 3.75-3 per cent. Now, some banks are encouraging this trend by providing finance up to 90 per cent to their customers to buy SSC and to pledge simultaneously the SSCs with the banks as security for loans.

Some bankers also complain that bank borrowing is being used by exporters to buy foreign exchange which is reflected in export proceeds. Low interest rates and low premium in the kerb make the exercise lucrative. The exporters declare the full price of their goods and are believed to be bringing back their retained earnings abroad because of international scrutiny of accounts after 9\11.

Of course, the buoyancy reported in the large-scale industry may explain some of the credit expansion. Yet the reverse flight of capital estimated between $500-700 million since December 2001 accounts for a high recourse to self-financing by the private sector. The State Bank may need to look more closely at how the credit flows are impacting on the economy and the financial system.

The core issue facing the commercial banks is excess liquidity that combines with low interest rates. And there is growing frustration and opposition among bankers to the interest rate policy. Over the past few years, T-bill rates have plummeted from the highs of over 16 per cent to 1.86 per cent.

To quote official figures, average weighted deposit rates have fallen from 4.02 per cent in July 2002 to February 3.04 per cent and lending rates have simultaneously dropped from 12.17 per cent to 9.36 per cent. It means that deposit rates have not fallen as fast as lending rates, reducing the spread between the two and resulting in squeeze in profit margins.

With excess liquidity, the banks want to book as many clients as possible, giving rise to perceptions about risks. In the given situation, some bankers see “non-performing loans in the making”. And to quote A.B. Shahid, managing director, Pak-Gulf Leasing Company, “the banks are selling their products without knowing the manufacturing cost.”