Bankers point out that opportunities of earning non-interest income are also directly linked with domestic economic growth. - File photo

Banking spread has started falling after decline in commercial interest rates because of policy rate cuts by the State Bank of Pakistan and the need of banks to expand their deposit base.

In September 2011, the difference between fresh average lending and deposit rates came down to 521 basis points from 557bps in January—a change of 36bps within nine months. This improvement in banking spread is derived by comparing lending and deposit rates, after excluding zero-rated loans and deposits of customers as well as all interbank lending and borrowing operations. The lowering of lending rates and increase in deposit rates, by almost an equal margin, have brought down the spread calculated under this new method.

The State Bank of Pakistan has started compiling average lending and deposit rates in this mode from the beginning of 2011 which makes it difficult to trace history of banking spread calculated in the similar way.

A closer scrutiny of interest rates, however, shows that the wedge between the average rates being charged on overall stock of loans and the average return offered on total stock of deposits is still very high—635 basis points to be precise. And in contrast to the falling trend seen in banking spread based on fresh average lending and deposit rates, the spread based on overall stock of loans and total deposits, has rather inched up! In January the spread thus calculated stood at 622bps.

Since the central bank was following a tight monetary policy till last year and interest rates were moving up, the banking spread remained high because low demand from the private sector amid excessive government borrowing made banks lethargic in deposit mobilisation.

“And that impeded upward movement in deposit rates at the desired speed,” explained head of credit division of a local bank.

“Over reliance on interest income was another factor that refrained banks from squeezing the spread,” he said. “Banks are still making the bulk of their profits through interest income but as non-interest income of some of them has recently increased, others are trying to follow suit. A bounce back in stock market after the global recession and the launching of some corporate finance certificates amid lucrative returns on National Saving Schemes compel banks to maintain deposit rates at reasonable levels.

On the other hand, a faster transmission of monetary policy signals drives down lending rates. All this, in effect, is reducing banking spread.”

Businessmen point out that bankers claim a decline in banking spread as they compare the average rate on all assets excluding zero-rated assets with the average rate on all deposits excluding zero-rated deposits. They say for them a better indicator is the one that is just opposite to it because the majority of private enterprises and almost all individuals bear the brunt of zero-rated loaning and it is they who often get zero returns on deposits on their current accounts operated frequently.

In January this year, fresh average lending rate including zero mark-ups but excluding interbank rate stood at 14.52 per cent.

Fresh average deposit rate including zero mark-ups but excluding interbank rate was 7.10 per cent. Thus the spread stood at 742 basis points. By the end of September, the spread slipped just a few basis points to 734bps as average lending rate slipped to 14.45 per cent but average deposit rate remained almost unchanged at 7.11 per cent.

“Unless there is fairer competition between banks of almost equal sizes one cannot expect a real decline in banking spread,” admitted head of an Islamic bank.

He said concentration of banking assets and liabilities within five or six major banks give them a chance to set the tone of interest rate movement after any change in monetary policy signals.

However, head of credit division of a large bank cited several other reasons that make it difficult for banks to cut the spread including loan defaults, lack of expertise among bank personnel for pre-disbursement credit assessment, tendency among people to make frequent withdrawals from saving accounts, low share of fixed deposits in the overall mix of deposits, concessional loans to exporters and other segments of borrowers etc.

Bankers claim that banking spread may continue to decline with an expected increase in private sector credit disbursement during this fiscal year on the back of higher productivity of large-scale manufacturing, recovery in consumer financing and continued expansion in domestic and external trade.

“When the private sector borrows from banks it shops around, negotiates borrowing rates and, in case of large deposits, somewhat dictates on deposit rates as well,” said treasurer of a local bank.

“This leaves little room for banks to continue to charge high interest rates without adequately increasing the deposit rates and that narrows down the spread.”

“Excessive government borrowings from banks on the other hand, as seen in the last two fiscal years give banks a chance to resist a decline in lending rates and allows them plenty of room to manipulate deposit rates. As a result, the spread shows little movement.”

Bankers point out that opportunities of earning non-interest income are also directly linked with domestic economic growth and more particularly with the expansion in domestic trade, inland movement of funds, activity in real estate and construction sectors.

“We expect positive developments in these areas which should help us in containing banking spread. A decline in inflation this year compared to the last year is also likely to keep our expenses within limits. That would also have a positive impact on the spread from the customers’ point of view,” said a senior executive of Habib Bank Ltd.