KARACHI, Jan 7: Banks started quoting Karachi Inter bank Offered Rate for two years and three years from Thursday and they are ready to use them for pricing corporate loans of similar tenures.

Banks quoted two-year and three-year KIBOR at 7.14 and 7.51 per cent respectively at a time when inter bank market ran short of cash due to outflow of about Rs27 billion last week through auction of treasury bills.

The market was so short of liquidity that it had to borrow overnight funds of Rs1.3 billion from the State Bank by pledging government securities at 7.5 per cent. Within the market, overnight funds were seen changing hands at around 7.4 per cent.

Bankers said they were ready to use two-year and three-year KIBOR as benchmark for pricing corporate loans of similar tenures after a while-probably after the announcement of the State Bank's monetary policy for the second half of this fiscal year. The central bank would announce the policy stance on January 19.

"There is still uncertainty about interest rates. So I think banks would take a little while before using two-year and three-year KIBOR (for pricing corporate loans)," said treasurer of a local bank. "Besides, even one-year KIBOR is being used only on a limited scale (for benchmarking mark-ups on corporate loans," he added.

The uncertainty about the interest rates that the banker referred to is not about which way it would move. Interest rates have already been moving upwards and are likely to continue rising but the financial market is not quite sure whether the central bank will allow interest rates to rise faster or it will continue to let them rise in a measured fashion.

The announcement of the SBP monetary policy for January-June 2005 may end this uncertainty. Businessmen said they were willing to avail of corporate loans priced at KIBOR-based mark-ups only if the interest rates were attractive.

"Initially corporates would try to get two-year, three-year loans (priced at KIBOR-based mark-ups) for relatively longer term working capital needs," said Mr Iqbal Ibrahim, a leading textile exporter.

"But of course they could get these loans for really long term investment, say for 10 years, if they feel that rolling over of two-year, three-year KIBOR-based loans would cost them right in the long term." Mr Ibrahim said how soon corporates show appetite for KIBOR-based loans for two years and three years would depend on how attractive rates the banks could offer.

Banks charge 1-2 percentage points over KIBOR from first class clients while pricing corporate loans. But they charge 3-5 percentage points over KIBOR from majority of borrowers.

Bankers say they charge higher premiums from the borrowers who have weak balance sheets and pose high risk of default. But businessmen say banks demand higher premiums over KIBOR from all small and medium size businesses and from those who have a short history of dealing with a particular bank.

KIBOR-based pricing of corporate loans is just 11-month old in Pakistan as it started on February 7, 2004 with up to six-month KIBOR used as a reference rate. Then, banks began to quote one-year KIBOR from April 7, 2004 and started using it for pricing one-year corporate loans.

But whereas six-month KIBOR has gained currency as a benchmark for pricing banks' corporate loans, one-year KIBOR is yet to become popular. With two-year and three-year KIBOR in place, interest rates structure in Pakistan is going to become more market-driven, though both banks and corporates may initially find it difficult to lend and borrow at KIBOR-based rates in these tenures.

"I believe banks will find it more feasible to use two-year and three-year KIBOR in pricing the derivatives rather than using them outright for pricing corporate loans," said head of treasury of a large local bank.

"Using KIBOR-based rates for pricing corporate loans beyond one year tenure requires a lot of expertise on the part of the banks to project interest rates movement in future," pointed out treasurer of a foreign bank. "Borrowers also may find it difficult to make two-year and three-year projections about interest rate movements."

So, in both cases it seems more practical that two-year and three-year KIBOR be used in derivatives, for pricing interest rates swaps between a few top class banks and borrowers.