THE cut in the central bank’s policy rate impacts banks’ decision to alter their lending rates with a lesser intensity. This is in sharp contrast from the case when the policy rate is increased.

This can be deduced from the findings of a SBP working paper of 2012, co-authored by three SBP officials and a senior lecturer of the University of Surrey.

The paper concluded that “during the period of monetary tightening, banking margins are counter cyclical and the overall pass-through of policy decisions to borrowers is greater during monetary contractions.”

Bank treasurers say this statement, by extension, suggests that during the period of monetary expansion, the overall pass-through of policy decisions to borrowers is smaller. “This effectively means that banks become less sensitive [in their decision to change interest rates] when the central bank cuts policy rates,” argues the treasurer of a local bank.

However, central bankers caution that inferring the reverse meaning of a statement derived through dedicated research requires even more research. But they generally agree that banks’ sensitivity to easing in the policy rate has become weaker.

And this isn’t without reasons. First, over the years, the government has become the largest bank borrower. Second, banks’ deposit mix is changing. And third, the duration of their investment portfolios has changed too.

In case of higher hikes in the policy rate, banks re-price their loans to small borrowers with sharper increases when compared to their credit to large borrowers

Currently, 60pc of the total outstanding stock of bank loans is with the government, against less than 30pc eight years ago. “This has some real implications for banks, including lesser provisioning requirements and stable interest incomes,” explains the treasurer of another bank.

“If banks are sure of earning continuous interest on a larger part of their loans, it is less difficult for them to re-adjust interest rates marginally downwards, particularly if they know that they can leave rates unchanged for the private sector if the cut in policy rate is nominal.”

Meanwhile, the linking of banks’ minimum deposit rate (MDR) with the SBP’s repo rate — at which banks park their daily surplus liquidity with the central bank — has encouraged banks to rely more on locked investment yields on long-term government debt papers. And this is why the revision of the monetary policy every two months does not bother them as much as it did when the MDR was not linked with the repo rate.

Recently, KASB Securities researched 12 top-tier and mid-sized banks and found that the sample had an earning sensitivity between minus 5pc and plus 6pc in case of a 50bps cut in the policy rate. Years earlier, this sensitivity ratio used to be in the range of 8-12pc.

The SBP working paper, mentioned earlier, highlights another important feature of a sudden big hike in the policy rate.

It says smaller and faster growing enterprises disproportionately share the burden of such a shock, and recalls how banks had resorted to credit rationing after the country conducted nuclear tests in 1998, which had drained liquidity out of the banking system. That draining was partly due to the tightening in monetary policy for stabilising the faltering rupee, bankers recall.

“No such thing happens when the central bank eases its monetary policy. Banks don’t discriminate against smaller and faster growing enterprises when they lower loan prices [if at all],” says the head of a local private bank.

“Most of such loans to firms are now on floating rates, as is the case with larger firms. So, if banks’ floating interest rates fall with the change in the rate of T-bills or PIBs, all borrowers get some benefit.”

In other words, in case of higher hikes in the policy rate, banks re-price their loans to small borrowers with sharper increases when compared to their credit to large borrowers. And they lower interest rates more equitably in case of monetary easing.

“In so doing, most banks expect that this even-handed treatment would boost the credit appetite of smaller and faster-growing firms, which suits banks in times of monetary expansion [and consequent increase in liquidity levels],” explains a former SBP official.

“This is becoming more relevant as banks’ private sector credit is not as much centered with a limited number of sizable companies as it used to be in the 1980s or 1990s.”

Senior bankers say the SBP’s mid-November decision to cut the policy rate by 50bps, after holding it unchanged for a year, would have a lesser impact on banks’ interest incomes.

Even though banks’ MDR has been linked with the SBP’s repo rate for some time, their deposit mix is such that the overall cost of deposits is not too high for many of them to warrant an immediate reduction.

That also means that banks might refrain from re-pricing their fresh loans downwards.

But one big reason for the shrinking private sector credit is that while some companies are sitting on cash piles, others are retiring old, expensive bank loans in hope for cheaper ones.

Between July 1 and November 7, the private sector’s net borrowing fell to just Rs8bn, against Rs86bn in the same period a year ago.

Published in Dawn, Economic & Business, November 24th, 2014