28 November 2004	Sunday	15 Shawwal 1425

KARACHI, Nov 27: The gap between fresh lending and deposit rates rose to 415 basis points in September from 386bps in June, showing an increase of 29bps within the first quarter of this fiscal year.

The spread between the interest rates that the banks charge from the borrower and the returns they pay to the depositor widened between July and September 2004 as the banks did not increase deposit rates in accordance with the increase in lending rates.

Data released by the State Bank show that weighted average lending rate of all the banks on fresh lending made in September rose from 5.05 per cent in June to 5.84 per cent in September. But the weighted average return on fresh bank deposits mobilized in September rose at a slower pace during this period -- from 1.19 per cent in June to 1.69 per cent in September.

In other words, whereas average the lending rate went up by 79bps, the average deposit rate moved up by 50bps.

From the start of the new fiscal year in July, the SBP started tightening interest rates to ward off inflationary pressures. This led the banks to increase their own lending rates. But as inflation kept rising in the first quarter of this fiscal year, despite interest rates tightening, the banks could not afford to leave the deposit rates unchanged at very low levels: (Consumer inflation rose by 9.18 per cent year-on-year in the first quarter). They had no option but to offer a higher return to the depositor to mobilize fresh deposits in the face of soaring inflation.

But most banks increased their lending rates by a wider margin than they raised the deposit rates that resulted in the widening of spread between the weighted average lending and deposit rates of the entire banking system. This happened because Pakistan's banking system has become market-oriented and the SBP only indirectly influences upon the banks' decision to change interest rates.

Besides, a host of factors limit the individuals' and companies' responses to rising gap between lending and deposit rates. "But this does not mean that the market does not adjust its responses whenever the need arises," says a senior executive of a foreign bank.

"Banks' ability to raise cheap deposits and make expensive lending is being challenged by the market forces. As the future offers more opportunities to both individuals and depositors, banks will have to ensure that the gap between lending and deposit rates does not rise abruptly."

In October, total deposits of the banking system declined to Rs2064.722 billion from Rs2065.766 billion, showing a fall of Rs1.44 billion. Some say this fall might have been caused by withdrawals made from the banking system during Ramazan, and as such it could be cyclical. But for others, it might also have been caused by banks' inability to mobilize deposits at very low rates. If the second proposition carries some weight, and seemingly it does, then the banks will find it difficult in future to keep raising cheap deposits even at times when they are increasing lending rates sharply.

Top bankers say looking at changes in the gap between lending and deposit rates during a quarter or even shorter periods it is not very helpful in analyzing the real trends. "You have to look at the changes for a longer period to capture the trend," said head of a local bank, explaining that banks always respond to interest rates tightening or loosening by the central bank with a lag of time. "Similarly they also decide to change the deposit rates in the light of fresh developments and that may not coincide with their decision to increase lending rates."

The SBP statistics show that whereas the gap between fresh lending and deposit rates in September expanded by 29bps, the gap between the overall lending and deposit rates increased by a much smaller margin -- only 5bps. The statistics show that the average lending rate on the entire stock of banking system loans went up from 6.49 per cent in June to 6.55 per cent in September, whereas the average lending rate on the entire stock of banking system deposits inched up from 1.21 per cent to 1.22 per cent during this period.

Thus the gap between average lending and deposit rates rose from 528bps in June to 533bps in September.

The reason why a big rise in average lending and deposit rates in July-September had a very little impact on the overall average lending and deposit rates is that advances made and deposits raised during a single quarter make up only a small portion of the total advances and total deposits of the banking system.