Reducing the banking spread

Walter Bagehot, one of the founders of The Economist, once said that the public’s trust is the most important asset for a financial institution. Yet Pakistani banks appear to be little concerned about matters such as their fiduciary duty to their depositors, making record high spreads at the expense of both depositors and borrowers. In Pakistan, with relatively nascent capital markets, the banking sector is the primary financial intermediary in exchange for a fee. That fee, known as the banking spread, is the difference between the interest rates that it charges its borrowers versus what it pays out to depositors. The banks can rightly argue that the high interest rate environment on the lending front is not their fault. High government borrowing, persistent fiscal deficits and the resultant rampant inflation are largely to blame for the lending rates remaining in double figures. But they cannot reasonably make a similar case about the rates that they pay out their depositors.

Many depositors feel that their money is not earning an adequate return and they are right to feel this way. The banking spread in Pakistan is 7.6 per cent according to the latest figures. In the US, this figure is closer to 3.3 per cent. (Higher figures are worse for depositors and better for the banks’ profits.) The SBP has already mandated minimum rates for savings accounts but this is clearly not enough to goad the banks into action. The long-term solution is increased competition from non-banking financial institutions such as mutual funds. The government has already instituted many policies to favour just such a spirit of competition. But the banks would do well to realise that many of their clients now have more choices and will refuse to be treated in such a miserly fashion.

Published in The Express Tribune, August 30^th, 2010.