According to the latest statistic of the financial sector, during the traumatic third quarter of 2008 a singularly worrying trend was the rising mismatch between growth rates of bank deposits and bank credit.

Although only for a fortnight both banks and their depositors experienced a scary rise in systemic risk not witnessed in recent years, it has left some scars on depositor confidence. These scars must be heeled very carefully because, in the coming months as credit recovery slows down, banks will need continuous inflow of fresh deposits to live through the squeeze caused by repayment of maturing deposits.

During July-September 2008, total bank deposits fell by three per cent (a hefty Rs 124 billion) over their June 30, 2008 level (Rs 4,188 billion). That’s a worrying drop because it also reduced the share of bank deposits from 76 per cent to 73.8 per cent of the total deposits in the financial system. In spite thereof, bank credit increased by 25.6 per cent over its June 30, 2008 level largely due to the slowdown effect.

To a large extent, the credit-deposit mismatch was sustained because of the recent hefty cuts in CLR ( cash liquidity ratio) to help banks overcome the liquidity crisis and contain systemic risk. The question begging an answer is “should banks become dependent on such emergency measures, or should they redouble their efforts for deposit mobilisation?” Prudence demands that they hasten the process of deposit mobilisation.

Not all banks are portraying this urgency. Some have offered attractive terms for deposits that include not just higher returns but the flexibility to temporarily borrow large chunks of those deposits as bridge finance facility. But the fact that overall bank deposits fell in spite thereof indicates that that’s not enough, and the reason is that the big banks haven’t actively joined this endeavour.

According to statistics, during third quarter-2008 National Bank of Pakistan, Habib Bank, MCB Bank, United Bank, Allied Bank and Bank of Punjab experienced a drop in their deposit bases. The combined drop in the deposits of these banks amounted to Rs 133.6 billion implying thereby that the smaller banks mobilised deposits worth Rs 9.6 billion to contain the overall fall to Rs. 124 billion.

Big banks have not yet appreciated the fact that risk perception alone was not the deciding factor; returns on deposits made a significant difference. Also, that big banks can’t afford to lose any more deposits because, given the size of their networks, the smaller banks’ have a limited capacity for taking on that challenge, though, within their limitations, they have done far better than the big banks.

It was repeatedly pointed out that the biggest single chunk of deposits (over 53 per cent of total) consists of saving deposits. This base must be expanded if the huge amount of money in (futile) circulation is to be sucked back into the banking system for productive use. But with inflation still in the 20 per cent rage, how do banks, especially big banks, expect to suck in saving deposits at a return of five percent per annum?

Big banks accounting for nearly 70 per cent of the country’s branch network have a huge responsibility in mopping up the liquidity going waste and fresh mobilising deposits. Traditionally, big banks mopped up the liquidity and partly funded smaller banks’ credit portfolios to keep the economy adequately supplied with requisite liquidity; laxity on their part could create serious problems for the entire financial sector.

While a large part of these deposit flowed into the money in circulation, undoubtedly a big chunk thereof found its way out of Pakistan – the fallout from rupee’s rapid weakening. Another free fall of the rupee could have a worse outcome – a stiffer liquidity crunch that could threaten the existence of banks with disproportionately large credit exposures. Banks therefore must vigorously prevent the fall of the rupee.

In spite of the above, another signal in the deposit graph that must be noted by the regulators is that, despite the recent turmoil in the financial market, by September 30, 2008 the share of foreign currency deposits in total bank deposits rose to 15.5 per cent from 12.3 percent in June 2007. This trend too owes itself to the rapid drop in the exchange value of the rupee, but has some positive implications as well.

With interest rates on deposits dropping rapidly around the world as even the robust economies lower interest rates to record lows, there is a chance that a fraction thereof could flow into Pakistan but only if domestic banks offer better returns; banks obviously can’t do that on their own. As done once before, the central bank must offer banks a decent premium over market rates for passing on to the depositors.

A premium ranging between 1 to 1.5 per cent over LIBOR would be far less than the cost of borrowing from international markets at premiums of up to five per cent. With a semblance of financial stability returning , (foreign exchange reserves at $10 billion) after availing the IMF package, small savers abroad (especially in the Middle East could be satisfied with a risk premium of 1 to 1.5 per cent per annum.

SBP could swap these deposits for rupees and afford banks the benefit of cheap rupee deposits i.e. live through the current stress by helping borderline borrowers to survive till the global economic scenario improves. With cheaper deposits, bank could lower lending rates, which is the demand of every trade association, and quite rightly so, to compete effectively in a period of contracting demand.

But in the long- term there will be no alternative to self-sufficiency in financial resources. The experience of 2008 must make banks accept this reality. Foreign direct and portfolio investment flows can’t be relied on, especially by countries like Pakistan that are likely to remain entangled in security problems in the foreseeable future, courtesy a history of short-sighted management of the state and its interests.

Also, that in developing countries, saving deposits will remain the main funding source. It is these deposits that deserve attractive returns along with frills, not deceptive descriptions of account operation whereby banks can recover unfair service charges. In fact, holders of these deposits who maintain a certain minimum balance must be offered some basic banking services free of charge.

Finally, there is no earthly reason why profit on saving deposits be must paid on half-yearly basis, why can’t it be paid monthly? If anything, such a practice will encourage depositors to draw (and spend often on wasteful consumption) as little as possible. Won’t that lower consumption and reduce demand pressures to bring down inflation? All these possibilities need bankers’ dispassionate consideration.