Banking spreads reach 20 year high

KARACHI:

Pakistan’s weighted average banking spread – the difference between the interest rate that banks charge on lending and the rate of return they pay on deposits – hit a two-decade high at 7.73% in the second quarter ended June 30, 2023.

JS Global Research reported that “weighted average banking spreads mark the highest quarter since at least 2004, rebounding from a low of 4.14% reported in the fourth quarter (Oct-Dec) of 2021.”

The research house further revealed that spreads widened significantly to 9.73% on new loans and deposits extended alone in the quarter under review (Apr-Jun 2023), compared to a low of 2.86% marked in the third quarter of the calendar year 2015.

Impact of rising central bank rates

The surge in banking spreads comes in the backdrop of the central bank’s benchmark policy rate reaching a historical high of 22%. This sharp increase in interest rates has played a significant role in widening the spread.

Speaking to The Express Tribune, Head of Research at Ismail Iqbal Securities, Fahad Rauf stated that the current account deposits played a key role in this widening. He highlighted that there was zero rate-of-return on the current account deposits, which make up around 40% of the total deposits, amounting to Rs23.7 trillion at present.

Government borrowing driving spreads

Banks have been extensively lending to the cash-strapped government at an unprecedented interest rate of around 23%, while demand for credit from the private sector and households remained low due to the soaring cost of credit.

“The high lending to the government at exorbitant interest rates is helping banks earn a high spread,” said Rauf.

He emphasised that the government should reduce its reliance on banks’ financing to create room for credit to the private sector. The heavy financing to the government has crowded out the private sector, hindering economic growth and revenue generation, he said.

Banks and the government debt

Banks extend financing to the government by investing in sovereign debt securities, including T-bills and Pakistan Investment Bonds (PIB). Consequently, their investment-to-deposit ratio (IDR) reached a high of 85% recently, while the advance-to-deposit ratio (ADR) – advances to the private sector – remained around 50%.

Concerns over government borrowing

In the latest auction of T-bills, the government borrowed Rs621 billion from commercial banks at a near-record high interest rate of 23%. The interest rate could surge to a new high in case the government would have acquire the targeted amount of Rs900 billion. However, the banks offered a total of Rs1.15 trillion in financing to the government.

The government has set a record high borrowing target of over Rs11 trillion in three months (Jul-Sep 2023) to repay old maturing debt to banks and meet budgeted expenditures. A significant portion of the government’s expenditure remains the interest payment on the total debt, standing at Rs59 trillion at present.

With 70% of the revenues collected by the Federal Board of Revenue (FBR) being utilised to pay interest, the quantum of interest payment has continued to surge with the hike in the central bank’s key policy rate. Interest payments surge by around Rs200 billion on the total debt every time the policy rate is hiked by one percentage point, it was learnt.

The policy rate was raised by 8.25% to 22% in the previous fiscal year, as demanded by the IMF to secure its latest loan programme of $3 billion in June 2023.

Published in The Express Tribune, July 26^th, 2023.

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