An Unhealthy trend: high rate-spread

An unhealthy trend
Unusual banking spread is one of the reasons of the stalled industrial and business growth in the country

 By Tahir Ali

The huge banking/rate spread — the difference between the average rates of returns on deposits and the average rate of interest on loans — in the country may have helped increase the incomes of banks but it surely is one of the biggest reasons of the stalled industrial/business growth and below capacity production in industries that result in increased joblessness. It also leads to less saving, less investment and unjust income distribution.

Despite enhanced net income — after tax income of banks which was minus Rs2.8bn in 2000 rose to Rs54.5bn by 2009 — banks are reluctant to increase the rates of return on deposits as high rate spread is also one of the main tools of profitability for banks.

According to a bank manager at the national bank, who wished not to be named, the average deposit rate is 5 percent against 15 percent average rate of interest in the country.

While the average rate spread is around 3-5 percent in most countries, it is much higher in Pakistan. According to the SBP data, it was 4.63 per cent in June 2003 but increased to 8.90 percent in July, 2011, which means that the lending rate is greater by that extent from the rate of deposits.

If high rate-spread indicates lack of efficiency and competitiveness in the banking system on the one hand, it also signifies the failure of regulatory authority — the State bank of Pakistan.

The SBP, which is authorised under the SBP Act, the Banking Companies Ordinance and some other laws to make sure that banks do not exploit the depositors or the borrowers and earn profits through legitimate business practices, needs to review the existing rate spread and bring it down to a normal range.

Successive SBP governors, including Dr Muhammad Yaqoob and Shamshad Akhtar, while acknowledging that depositors were getting negative returns, had also urged large banks to increase the return on deposits or the State Bank would intervene to get results.

According to one estimate, interest rate in Pakistan is highest in the region. With business and industries already hit hard by terrorism and energy shortage, lending rates need to be brought down to a single digit to save them from bankruptcy, encourage private loans demand and spur economic growth in the country.

But if the banks reduce the rate of interest on loans but simultaneously cut down the deposit rates as well or increase both the rates of interests and rates of return on deposits by the same amount, the spread rate will practically remain high. So, any effort to slash the spread not only requires cutting down the lending rate but also increasing rates on deposits.

Despite inflation of around three percent, the United States decreased interest rates to almost zero percent and the European Union to just above one percent to push growth and create jobs.

High rate of interest, the main factor for huge rate spread on the back of small returns on deposits, is one of the main reasons for the rising loan defaults, below capacity working of industries, job cuts and surging non-performing loans calculated at Rs630bn in September 2011.

The high cost of funds is not only leading to industrial closures and defaults, the government, taking huge loans from commercial banks, is also drastically affected by the trend and is compelled to slash development funds, increasingly rely on borrowing and printing of new currency to meet its fiscal needs.

The difference in the interest rate being paid by the government for the domestic and external loans will illustrate the point. At the current rate of interest (14-15 percent), the government’s debt servicing costs stand at $10bn on domestic loans of$80bn. Conversely, it has to spend only around $2bn on external loans of $61bn given at an average rate of three per cent.

It is worth asking that when some local entrepreneurs in Mardan could offer as much as 50 percent net profit per annum through their investment schemes, why banks can’t increase the amount of profit on deposits for the depositors, the lifeline of the banking system in any society?

“One thought that privatisation of banks would entail better services at reduced cost for most of the customers, but it has, conversely, made banking costlier, exploitative and anti-poor,” argues a lecturer of economics, wishing anonymity.

Commercial banks are earning huge sums of money due to high interest rate on the one hand and giving less profit on deposits on the other. Why would people go for depositing their money in banks when they could reap comparatively higher returns on their savings by spending them in real assets like investment in real estates, transport and other businesses?,” he asks.

While the banks have reduced rate of returns and increased lending rates to augment their financial gains, the poor consumers have been the real losers. High rate of inflation of over 15 percent per year for the last several years has aggravated the problem.

Depositors receive negative returns on savings when the rate of return on savings is less than the rate of inflation. For example, if consumers are given 5 percent of returns on their savings and inflation rate is 15 percent, savers will annually lose 10 percent of the purchasing power of their bank deposits.0

Commercial banks, both public and private, are believed to have deprived the depositors of around Rs1100 billion profit during the last 10 years by only avoiding the inflation rate formula of 2001 applied to fix the profit rate, says a report.

The absence of a genuine investment opportunities or ignorance thereof on part of the people notwithstanding, people have but to keep their savings in these less attractive bank accounts.

Quite a few people in the country, under the urge to avoid Riba (fixed return on savings) keep their savings in current accounts with no interests thereon. But banks are free to use their amounts any way they want and even earn money over these amounts by lending it to others.

According to a news report, bank deposits increased by 269 percent from 2001 to 2010, bank assets by 268 percent whereas growth in pre-tax profit has been 9,991 percent. He said banks earned Rs1.1 billion in 2001 which rose to Rs111bn in 2010 but the real average rate of return (minus rate of inflation) which was 3 per cent positive in 2001 came down to minus 6.5 percent in 2010.

Apparently, depositors are deprived of their due profit share because of the policy of writing off loans to the influential.

Banks, apparently, are more interested in interest profit than affording genuine and high rewarding investment chances to their consumers. And why would the banks increase the deposit rates and decrease interest on loans in the backdrop of excessive government borrowing which could help it overcome the low demand from the private sector.

Loan defaults, frequent withdrawal by the deposit holders from their accounts, less fixed deposits, concessional loans, high rate of inflation and incessant devaluation of currency etc hinder banks from decreasing the spread,” says the manager.

Low-cost loans are opposed for reasons that they trigger inflation that’s why the SBP followed a tight monetary policy that kept the policy rate high. But the question is did this policy succeed? Could inflation be controlled and economy improved?


About Tahir Ali Khan (Official)
I am an academic, columnist, and a social worker.

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