Banking spreads are falling because unlike in the past, the dip in banks’ lending rate is not matched by a decline in their deposit rates.

The State Bank of Pakistan’s decision to link banks’ minimum deposit rate, or MDR, with its own repo rate is keeping returns on deposits from dropping too fast. But lending rates, which are mostly tied with Treasury bill rates, are declining because banks’ investment in T-Bills is falling.

Banks, by the way, have resumed lending to the private sector, whereas the government continues to make fresh borrowings from the SBP rather than from commercial banks.

Calculated on the basis of fresh lending and deposit rates (minus zero-rated, minus inter-bank transactions), banking spreads fell from 410bps in December 2012 to 328bps in December 2013.

However, whereas the average fresh lending rate declined from 11.65pc to 10.99pc, average fresh deposit rate inched up from 7.55pc to 7.71 per cent.

Central bankers say till September 2013, the fall in the average lending rates used to be followed by dips in the average deposit rate, but after the linking of banks’ MDR with the SBP’s repo rate from October 1, the situation has changed.

And SBP statistics support this development. The average deposit rate (minus zero-rated, minus inter-bank), declined by 55bps, from 7.55pc in December 2012 to 7pc in September 2013, when the average lending rate (minus zero-rate, minus inter-bank) fell by 115bps, from 11.65pc to 10.50pc.

Senior bankers say some other factors also strengthened the average deposit rate amidst a declining interest rate environment. The government didn’t make any net borrowing from banks during October-December 2013; it retired bank debts on a net basis.

Besides, deposit mobilisation of banks remained strong. The twin factors raised banks’ liquidity levels. “Private sector credit did rise, but not fast enough to absorb very large volumes of funds. Banks’ average lending rates, therefore, showed a steeper decline than in the past,” says the treasurer of a local bank.

Banks’ net lending to the private sector totalled Rs256 billion in about seven months of this fiscal year (up to January 24), against year-ago lending of Rs94 billion. On the other hand, the government’s borrowing from banks remained negative by Rs89 billion during this period.

“When auctions of government securities after January 24 would be accounted for in future statistics, government borrowing from banks would soon turn positive,” insists a foreign bank’s treasurer.

Normally, some seasonal private sector credit demand remains up till March, and afterwards, credit retirement starts due to the cyclical nature of short-term loans. That is why the government may find it cost-effective to borrow more from banks in the April-June quarter, taking advantage of their enhanced liquidity levels.

Most bank treasurers are projecting things on these lines, and some even point out that this year, higher government borrowings from banks has already started from late January, pointing to a huge auction of Rs730 billion worth of T bills in the last week of the month.

Officials of the ministry of finance involved in domestic debt management generally agree that in the second half of this fiscal year, net government borrowings from banks would be positive.

But they argue that several factors, including actual reduction in borrowing from the SBP, the extent of success in selling Treasury bills through bourses and the size of fresh investment in National Savings Scheme would determine the volumes of additional borrowing from commercial banks between now and June.

They say the fiscal deficit, growth in tax and non-tax revenues, success or failure in realising targeted privatisation proceeds and volume of foreign exchange inflows would matter as well.

Some bankers point out that their lending rates are increasingly being influenced by intra-industry competition. Mid-sized banks are keeping their cost of operations under check and are able to make loans at competitive rates, sometimes at rates lower than those of larger banks, executives of such banks claim.

On the other hand, “big banks are nowadays pricing fresh loans to prime borrowers at very low rates, in some cases just half per cent plus T-bill rates, with more hope in their hearts and less prudence in their minds,” remarks the head of a mid-sized bank.

“As a result, their average lending rates are falling faster than they should. The resultant squeeze in banking spreads, if not compensated by aggressive non-interest income, would land these banks in trouble sooner or later.”

Growing competition between banks in deposit mobilisation is also keeping average deposit rates from falling. And what makes this competition real is that unlike in the past, banks are no more forming cartels. Each bank is setting its deposit rates based on its own’ financial strength and strategic view, senior bankers say.

In the past, the Competition Commission of Pakistan had fined a number of banks on charges of making cartelised decisions on setting deposit rates.