July 20, 2006	Thursday	Jumadi-ul-Sani 23, 1427

KARACHI, July 19: The first impact of the State Bank’s decision to increase the banks’ cash reserve requirements emerged in the form of higher interest rate in the inter-bank market on Wednesday.

The State Bank on Tuesday had increased the cash reserve requirement (CRR) by 2 per cent to 7 per cent and statutory liquidity requirement (SLR) by 3 per cent to 18 per cent. The decision immediately resulted in outflow of liquidity from banks’ to the SBP. The deadline to meet the requirements is July 22.

This outflow made the money expensive and pushed the 6-month benchmark Karachi Inter-Bank Offered Rate (Kibor) by 56 basis points to 9.07 per cent from earlier 8.51 per cent per annum. Three-month KIBOR increased by 66 basis points to 9.77 per cent.

Bankers said the rate could further escalate as the deadline for reserves requirement approaching closer.

They said the decision would also cast negative impact on profitability of the banks, which have been making record profits for last couple of years. They further said that the calculation was simple as less money would be available for lending, which is the source of biggest income for banks. Banks’ Net Interest Income remained very high during the last two years and now after the SBP’s decision it would shrink.

A leading brokerage house calculated the impact on income of banks, which shows that the banks’ would be deprived of 2 per cent of their total deposits and that would be translated into a loss of 2 to 5 per cent decline in their profits.

“Increase in CRR requirement means that banks will be deprived of 2 per cent of their deposits, which will be kept with SBP at zero return. Assuming a minimum return of 8.5 per cent (6-month T-bills rate), this loss of 2 per cent of deposit would lower the expected earnings of the banks by 2--5 per cent with other things remaining constant,” said an analyst.

The State Bank, which has been struggling to bring down the inflation and monetary growth under control for last three years, used the reserves requirements for banks first time as a tool to deal with the situation. The central bank used to enter into market frequently to mop up the excess liquidity from the system but the credit flows towards the private sector kept increasing.

Analysts and bankers said that banks with high advance-to-deposit ratio

(ADR) would hit badly with the decision and they would have to manage liquidity on war footing.

On the other hand, the search for deposits by the banks would certainly result into higher return on deposits. Banks’ requirements for liquidity would compel them to increase the return and this will cut the high banking spread. The high banking spread has been under severe criticism by the economists and the depositors who were getting meager return on their deposits while the banks were making record profits with banking spread as high as 7.5 per cent.

“I think the banking spread would see an immediate decline and the return on deposits would increase in the range of 1 to 2 per cent in next couple of months,” said a banker. He believed that banks would launch new products with improved incentives for the customers.

Analysts said that an amount of Rs140 billion would outflow from the banking system with the increase of CRR and SLR. The small banks whose ADR is 80 to 90 per cent would suffer more as they would be required to manage liquidity immediately to meet the deadline of July 22, and they would borrow this money from the inter-bank. However, the banks with low ADR like NBP--with 59 per cent ADR-- will be the beneficiary.

The impact on stocks market is also significant as the banks would require cash and some of them may withdraw their investment from share market. Further, banks may reduce their investment in stocks while the badla rate would also see a rise.