KARACHI, Dec 8: Rising competition for deposits forced banks to increase returns on their deposits which resulted in the decline of banking spread. The State Bank, which released latest figures showing decline in the banking spread, has been making efforts to improve returns to depositors. However, it could not compel banks to increase return on deposits.

Latest information provided by the SBP revealed that the banking spread declined by 27 basis points to 7.19 per cent in October 2007. Last year during the same month, the banking spread was 7.46 per cent.

The decline of banking spread means the depositors were getting better return. However, the return was still negative in the presence of above nine per cent inflation.

The SBP governor last year assured that the central bank would make efforts to bring the negative return to positive in terms of real interest rate but things are yet to change.

“The recent decline in the banking spread is also because of State Bank which provided incentives to banks for raising deposits for longer periods,” said a banker.

The SBP had issued a circular by mid of the current year providing incentives to banks involved in raising deposits for a longer period.

The banking sector is in the worst shape in terms of long tenure deposits.

Banks’ balance-sheets show that most of the deposits of banks were of not more than three years.

Bankers said the banks were offering even double digit returns to deposits on longer tenure of deposits which increased the cost of deposits.

Analysts said prevailing liquidity shortage also forced banks to get deposits at a higher rate instead of borrowing at the costly inter-bank money rate.

“The higher cost of deposits would certainly hit banking profits this year,” said Aamir Saleem, a brokerage house analyst.

The nine-month results of the banks showed that profits have already declined compared to last year while analysts believe that the banking sector profits would fall by 15 to 18 per cent by the end of this year.

Bankers also pointed towards a draft circular of the State Bank which would further hamper profitability of the banking sector.

The State Bank in September 2007 issued a draft circular completely withdrawing the benefit of Forced Sale Value (FSV) against all NPLs for calculating provisioning requirement which would hit the profits of entire banking sector.

According to the draft, banks will have to go for a 100 per cent provisioning against the non-performing loans (NPLs) or loss; however, liquid assets would be subtracted to calculate for provisioning against NPLs.

The draft jolted the banking sector fearing further loss of profitability with the 100 per cent provisioning.

“The draft says where the interest or principal is overdue by one year or more from the due date, provision of 100pc of the difference resulting from the outstanding balance of principal less the amount of liquid assets, would take place. The amount of liquid assets would be realisable without recourse to a court of law.”

Analysts were also of the view that due to less credit outflows from the banking sector, the interest income of banks would face negative impact.