February 20, 2006	Monday	Muharram 21, 1427

THE SBP Governor Dr Shamshad Akhtar while presiding over a mid-term review meeting of the national credit consultative council (NCCC) in January last, expressed concern over the rising banking spread and emphasized the need for shifting some benefits to depositors in the wake of rising lending rates.

A time series of the data on scheduled banks deposits, advances and also the weighted average deposit and lending rates are available on the SBP web site. The computed spread between the weighted average deposit and weighted average lending rates (All banks and excluding the zero per cent mark up) showed that the spread which was 8.59 per cent as on end June, 2002 declined to 7.32 per cent as on end June,03 and further to 6.00 per cent as on end June 04.

Although the weighted average deposit rate increased to 1.89 per cent as on end June, 05 (from 1.28 per cent FY04) and further to 3.53 per cent as on end December,05, nonetheless, the spread did not exceed 6.92 per cent because of the weighted average lending rate which increased to 8.81 per cent as on end June,05 (from 7.28 per cent FY04) and further to 10.36 per cent as on end December, 05.

Since the rate of inflation in the country has all along been higher than the nominal deposit rates during the past five years, the depositors have been getting a negative real rate of return on their hard earned small savings placed with banks.

Before proceeding further let us identify, first, as to which specific category of depositors has been adversely affected with the low deposit rates. The SBP has been publishing data on bank deposits in five broad categories namely, current deposits and other deposit (zero rate of return), call deposits, saving deposits and fixed or time deposits of different maturities ranging from less than six months to five years and more.

During the past six years ended FY05, the value of deposits under savings account amounted to between 51 per cent to 57 per cent of total deposits, and 18 per cent to 20 per cent were categorized as fixed or time deposits.

The ratio of current and other zero- rate deposits to total deposits was between 25 per cent to 28 per cent each year. As a matter of fact, it is not only the one segment of the society that had been the worst sufferer due to lower deposit rates, instead it is detrimental to the pace of generation of savings/investment in the country.

The impact of negative deposit rate was exacerbated with a variety of service charges that is charged by banks to their account holders. The most significant of these arbitrary service charges was the deduction of a fixed amount of penalty (non-refundable) when the average balance was below Rs10,000 in the PLS saving account at the end of month.

Another important area of the banking system was the disbursal pattern of bank advances. As per the latest available data for full year, we have computed the percentage share of different size of account holders both in total deposits and total advances given by commercial banks during FY05.

The account holders falling under the size of less than Rs1 million accounted for plus 55 per cent of total deposits while their share in total advances was 17 per cent only in the same year.

Likewise, the account holders falling in the bracket of Rs10 million and above availed of a larger share (more than 68 per cent) of total advances as against their contribution to total deposits was about 31 per cent in the same year.

Nonetheless, the account holders falling in the category of Rs1 million and less than Rs10 million exhibited an incredible equity as their share was 13.61 and 13.44 per cent in total advances and total deposits respectively.

The foregoing analysis of SBP’s statistics reflected that banking reforms introduced more than a decade ago has not yet been able to improve efficiency of the local banks to the extent of providing access of bank advances to all the segments of the society adequately.

The small account holders which have been contributing a robust deposit base to the banks have neither been getting a corresponding share in total bank advances nor receiving even a positive real deposit rate which is their legitimate right.

The regulating authorities have been showing their inability to improve the lot of the small deposit holder as their plea is that under the market based financial system the SBP or the MoF cannot intervene in the banks’ day to day function and issue directives either to reduce the banks’ lending rates or increase the deposit rates.

Notwithstanding this argument, the regulating authorities can control the inflation which has been the root cause in denying the deposit holders at least get a positive return on their deposits.

An abstract from an empirical study, “Does judicial efficiency lower the cost of credit?” (by Laeven & Majnoni) undertaken in the World Bank is reproduced to indicate its vital bearing on the existing banking management in Pakistan: ‘We find that judicial efficiency and inflation rates are the main drivers of interest rate spreads across countries.

Our result suggest that improvements in judicial efficiency and judicial enforcement of debt contracts are critical to lowering the cost of financial intermediation for households and firms.’

It is true that till end December-1999, the cost of financial intermediation, particularly in the public sector commercial and specialized banks (like IDBP & ADBP etc.,) was higher mainly due to the larger provision for non-performing loans (NPL) which was occurring due to more defaults in the wake of rising advance rates and unsatisfactory rates of recovery and also the mounting administrative cost which was attributed to overstaffing in these banks.

However, since the Musharraf government took over from October, 1999 a number of measures were introduced to strengthen the financial sector reforms which also included expediting the process of privatisation. The existing banking sector is overwhelmingly composed of the private sector banks which are functioning on purely competitive basis and without undue intervention by the regulating authorities.

The private commercial banks focused their attention on improving the asset quality and also streamlined the process of recovery of their non-performing loans. The SBP has conceded the fact in its annual reports since 2000 that there has been a steady improvement in the asset quality of banks as reflected by the decline in net non-performing loans to net advances ratio up to end June,05.

This means that contrary to the condition prevailing till 1999 when the banks were required to make larger provision for NPL, now this provision has been shrinking both in absolute and relative terms. Similarly, the share of administrative cost in the total cost of financial intermediation should have declined compared with that of in 1999 as the ‘overstaffing problem’ has also been solved through ‘golden hand shake schemes’ in banks.

In fact, the issue of rising banking spread had cropped up with the easing of monetary policy which the SBP deliberately followed enabling the federal government to reduce its fiscal deficit which had swelled to 6.6 per cent of GDP in FY02. The easy monetary stance not only brought down the benchmark six month Treasury bill rate to an all time low level but also led to decline in the weighted average lending and weighted average deposit rates.

The federal government wholeheartedly welcomed the low interest rate policy as they replaced the costly market treasury bills purchased earlier direct from the SBP outside the regular auction with the T-Bills sold to banks through auction at the much cheaper market rate.

The loose monetary stance coupled with prudent domestic debt management policy was one of the major factors in reducing the fiscal deficit to 3.3 of GDP in FY05. The SBP also fully supported the commercial banks to diversify their loan portfolios from the traditional corporate sector to new avenues such as consumer financing through liberal grant of personal loans and credit cards to the individuals. The liberal credit to the private sector was made possible by the higher credit to deposit ratio (CDR) which reached the level of 76.7 per cent at the end FY05 compared with the level of 68.3 per cent at end FY98.

It may thus be concluded that the inflationary pressure which was building in the economy due to the excess demand conditions for the last three years has not been arrested as yet. In our opinion, the tightening stance of the monetary policy should be made more effective by increasing the SBP’s repo rate (Discount Rate) which will enable the SBP to enhance the benchmark six monthly T-Bill rate at the auction. The higher yield on T-Bills will induce the banks to divert their loaning from high risk portfolios to investment in government paper. The banks can then be expected to pass on a portion of their investment income to their depositors.