KARACHI, Aug 18: Concerned about the sustainability of low interest rates, banks are urging regulators to speed up plans to set up a derivatives market as a hedge against loan risks.

The absence of derivatives in the banking sector is forcing banks to price new loans at floating rates rather than fixed ones on fears that interest rates in Pakistan, which are currently at historic lows, will start rising as part of a global trend.

Bankers here agree that the current low interest rate environment is looking more unsustainable by the day.

Naeem Abdullah, head of financial markets at ABN Amro Bank in Karachi, said customers were keen to borrow at fixed rates, but banks could not hedge that risk due to an absence of derivative products in Pakistan, such as interest rate swaps.

“Banks are reluctant to give fixed-rate long-term loans because of their inability to hedge interest rate risks,” he said.

To address the problem, the State Bank is working with a committee of the Financial Market Association - a group of treasury dealers - to introduce interest rate swaps and forward rate agreements in the first phase of starting derivatives trading in Pakistan.

The committee comprises five major banks; three foreign ones, ABN Amro Bank, Citibank, Standard Chartered, and two state-run banks, Habib Bank and National Bank.

“There is a need for interest rate swaps in the Pakistani market to enable banks to hedge against any adverse interest rate movements in the long-run,” said a treasury dealer on the committee.

A monetary expert said commercial banks should be prepared to take more risk on companies in a growing economy rather than exposing them to interest rate fluctuations.

Bankers believe interest rates have hit bottom following a far sharper-than-expected fall in debt yields and lending rates due to surplus liquidity in the financial system. The 10-year government bond currently yields 4.56pc, down from 9.58pc a year ago.

Meanwhile, the central bank has kept its benchmark discount rate — at which it lends money to banks for up to three days — at a record low of 7.5pc since November 2002.

The wide gap between debt yields and the discount rate is being seen by many in the market as a sign of risk for fixed-term lending because the higher discount rate suggests there is room for yields on government assets and lending rates to rise.

Naz Chohan, head of fixed-income at brokerage KASB Securities, said some companies are incorporating exit clauses, such as call options, in their loan terms to guard against the impact of higher interest rates. Such clauses were almost non-existent two years ago. The wider fear is that higher interest rates in the international market will undermine foreign exchange inflows, which have been a major fillip to the economy.

But bankers agree that introducing financial instruments that could cushion loans risk triggered by a likely rise in interest rates has now become a matter of urgency.—Dow Jones Newswires