KARACHI, June 18: Banks are increasingly using floating rates to price their medium- to long-term loans rather than going for fixed rates to ensure that volatility in interest rates does not eat into their profits.

“We are pricing our medium- and long-term loans more on floating rates than on fixed rates,” said head of credit of a large local bank.

“The reason is the direction of the monetary policy is not clear. The SBP discount rate that used to be the anchor of its monetary policy has become a mere penal rate,” he explained.

The central bank has kept its discount rate unchanged since November last year but at the same time allowed the treasury bills rate to fall drastically. The spread between the discount rate and the treasury bills rate that once used to be 2-3 per cent has widened to 5.5 per cent. This has caused anxiety among the bankers who now see the SBP discount rate as a mere penal rate for those who go to the SBP discount window to borrow against government securities for up to three days. “It is rather the treasury bills yield that now signals the banks on the need for revisiting their lending rates — discount rate has seemingly become irrelevant,” said head of treasury of a large foreign bank.

Economist Dr. Javed Akbar Ansari says experience shows that the discount rate has become ineffective in moving the banks lending rates in the desired direction. He says banks are not making long-term loans on fixed terms loans — and the result is that the industrial base of the country is not expanding.

Bankers say what deters them from making long-term loans — and that too on fixed rates — is that there does not exist in Pakistan a long-term yield curve. They say Pakistan Investment Bonds were launched a few years ago for this purpose but they have failed to establish a yield curve. Many of them think the government is partly responsible for this as no serious effort has been made to realign the short- and long-term rates in a manner that can help the investor project interest rate risks.

Government officials and central bankers say bankers too are to be blamed for not playing their due role in establishing a long-term yield curve through PIBs. They say many banks were in the habit of unnecessarily and imprudently stockpiling PIBs that kept its yield from coming down to the level where it should have been. “Until recently the banks were also busy building inventory of treasury bills instead of looking for more profitable ways of using their surplus money,” commented a senior central banker.

All this has led to a situation where the bankers say signals on monetary policy stance are confusing — and where the central bankers insist that a stable monetary policy has been in place — and that it is less likely to change in the near-term.

Irrespective of this the central bank itself is encouraging banks to go for floating rates in financing long-term borrowing needs of their customers to manage interest rate risks. In its circular issued to banks last week the SBP said they should develop “floating rate products for extending housing loans thereby managing interest rate risk to avoid its adverse effects.”

But bankers say developing floating rate products for long-term financing such as in the housing sector becomes difficult with the SBP discount rate having become irrelevant and with no long-term yield curve established through PIBs. “Using the six- month or one-year T-bills as base rate for developing floating rate products for long-term financing is still more difficult,” says head of credit division of a large local bank. T-bills rate are vulnerable to wider and wilder fluctuations (as experience has shown) on the basis of liquidity available in inter-bank market.

SBP discount rate should theoretically serve as a base rate because it is supposed to be the anchor of the monetary policy and the course of monetary policy does not change overnight. It does change only when overall economic situation demands it. “But since the discount rate has now become irrelevant in such cases the only thing banks can use as a base rate is the yield on PIBs,” says treasurer of a major foreign bank. “But the way the government manipulates the market (to achieve the desired yield on PIBs to avoid deeper cuts in NSS rates) makes it too difficult.”

But senior bankers managing credit portfolios of banks say that developing floating rates for long-term loaning in housing and other sectors is not that difficult if the rates do have some caps and floors.

That the banks need to look for efficient ways to make long-term loans can hardly be emphasised because the banking system may continue to record rising liquidity levels backed by larger inward foreign exchange inflows. Overseas Pakistanis are sending more money back home — not only because they find no safe heavens abroad for their hard-earned money after 9/11 but also because real return in Pakistan’s financial markets is much higher than in the United States and other developed economies.