KARACHI, Jan 4: The difference between average lending and deposit rates of all the banks combined crept up to 540 basis points at the end of November 2004 from 528bps at the end of June 2004, according to data released by the State Bank of Pakistan.
At end-June weighted average lending rate was 6.49 per cent whereas weighted average deposit rate was 1.21 per cent. So the difference between the two was 528bps. At the end of November, however, average lending rate rose to 6.61 per cent but average deposit rate remained unchanged at 1.21 per cent. The gap between the two widened to 540bps.
An increase of 12bps in the spread between lending and deposit rates within first five months of this fiscal year is not surprising as the central bank has tightened interest rates during this period to fight high inflation.
Inflation in July-November 2004 went up by 9.1 per cent year-on-year and the central bank has projected full fiscal year inflation in the range of 7.6-8.2 per cent against the initial target of 5 per cent.
It has also indicated that it will tighten interest rates further to check inflation. Inflation seems set to rise further after the two successive oil price hikes, after a seven-month freezing, the first one in middle of December and the second one at the start of this month.
When the central bank tightens interest rates to fight inflation, banks invest more in T-bills earning a higher return and get muscles to demand increased markup on private sector lending.
Tightening of treasury bills rates also increases the markup on private sector loans with floating interest rates tied with the T-bills yield. On top of all, it also makes export loans dearer as six-month T-bills yield serves as the benchmark for markup on these loans.
The cost of borrowing of state-run enterprises also goes up because T-bills rates also serve as the benchmark to determine it. When the central bank increases T-bills rates, it also reflects in Karachi Inter-bank Offered Rates (Kibor) and the markup on all loans, obtained by the private sector as well as state-run enterprises, moves up if these are based on Kibor.
The cost of government borrowing itself increases in the first place in the wake of increasing T-bills rate because the government borrows from banks through these very bills, and sometimes through longer term bonds the yields on which also normally rise when T-bills rates increase.
During July-November 2004, the State Bank increased the weighted average yields on three-month, six-month and one-year bills by 208bps, 167bps and 224bps to 3.78pc, 3.74pc and 4.43pc respectively. The yields on three-year, five-year and ten-year Pakistan Investment Bonds, however, remained unchanged at 4.23 per cent, 5.27 per cent and 7.13 per cent respectively.
On the other hand, six-month Kibor that serves as a benchmark for pricing a variety of corporate loans increased by 275 basis points to 5.72 per cent at end-November from 2.97 per cent at end-June.
The foregoing facts provide justification for the increase seen in the average lending rates of banks in five months to November. But the lending rate had not moved up had there been no strong private sector credit demand.
The private sector showed a big appetite for funds in July-November and it borrowed Rs163 billion from the banks during this period, against the full fiscal year target of Rs200 billion. Senior bankers furnish all the above-mentioned facts to defend the increase in average lending rates of banks in the first five months of this fiscal year.
As for the average deposit rate that was at 1.21 per cent in November, unchanged from its June level, excess availability of liquid money in the economy can be cited as a key reason for this phenomenon. When banks can generate enough deposits at low rates, why on earth they should offer a higher return?
In five months to November 2004, total deposits increased by Rs100 billion to Rs2093 billion. This pace of growth was much faster than in the comparable period of 2003 when the deposits had increased by Rs72 billion.
There are several reasons for such a high growth in bank deposits even when the returns on them remained static. The most important of them all is that as the economy grows, both the government and the private sector spending increases, and higher spending leads to growth in bank deposits.
Secondly when inflation moves up, people tend to put more money in banks fearing the loss of real purchasing power of the cash in hand. They do this more when they feel that holding cash is too risky in the face of worsening law and order situation.
Finally, when corporates and individuals get large loans from banks they do not consume it at once and keep it in their deposits for the time being. That also leads to a growth in banks' deposit base. And, as the economy gets more and more documented and increasing number of transactions takes place through banks, this too raises bank deposits.
Even if people and companies make investment in stock market or in the documented segments of the real estate, the money put in these sectors finally flows into the banking system and increases the bank deposits.
So, bank deposits grew rapidly in July-November 2004 despite carrying low returns due to the reasons cited above. But as a thumb rule, a rising gap between lending and deposit rates indicates that banks need to improve their performance because a narrow gap often means efficient banking practices.