Banking spread: Minimum deposit rate unlikely to go down, says analysts

Brokerage firms say recent rumours represent hope rather than reality.

Meiryum Ali July 11, 2013
As taxation and new budget proposals in the coming months bring in the inflation, discount rates are expected to rise between 1% and 1.5%. PHOTO: FILE

KARACHI: With interest rates being slashed, is it too much to ask for the minimum deposit rate to go down too? It is the question on every commercial banker’s mind, and rumours going around McLeod Road about the possibility have certainly excited many people, but BMA Capital and Foundation Securities think it is unlikely to happen.

Analysts at both investment banks strongly contested the recent rumour that the State Bank of Pakistan is willing to reduce the minimum deposit rate (MDR), the minimum interest rate that banks are required to pay depositors. A reduction in MDR would increase commercial banks’ net interest margin, which is the difference between the average rate at which they lend out money to borrowers and the average interest they pay out to depositors.

Both BMA’s Furqan Punjani and Foundation’s Syed Asad Ahmed suggested that the only way the banking spread is going to increase is through the projected increase of interest rates.

“Historically, following any cut in policy [interest] rates, the commercial banks have always lobbied for a similar treatment for MDR,” wrote Punjani, in a note issued to clients on Thursday. “Taking cue from earlier responses of the central bank, which were to refrain from providing any support to the banks, we reject the market’s basis for rejoicing.”

The minimum deposit rate was not always an issue. In 2008, when the central bank imposed a minimum deposit rate of 5%, interest rates were high enough to sustain the higher cost of deposits. In fact, banking spreads actually increased by 0.29% in the year immediately following the MDR imposition.

But since September 2011, lending interest rates have been cut by almost 5%, with the overall banking sector spread dropping by 1.29% since October 2011. The cuts were fuelled by a desire on the part of the central bank to kick start growth, and helped by the fact that inflation had relatively slowed down. But they also seriously hit the banking sector profit margins, because while the discount rates went down, the minimum deposit rate stubbornly remained the same, and then increased to 6% in May 2012.

That is why commercial banks are talking about the MDR being reduced by, at the very least, 0.5% to 1%. But the central bank seems to think otherwise. Pakistan has a banking spread of 4.48% according to the Foundation Securities report, a spread that is among the highest in the region. So for now the central bank is keen on maintaining the MDR status quo.

In fact the only way that spread is going to change is because of the IMF program. As taxation and new budget proposals in the coming months bring in the inflation, discount rates are expected to rise between 1% and 1.5%.  Banking spreads go up, and, the current easing cycle loses its steam.

But that projected scenario is about as optimistic as the banks should expect. “We strongly believe that double treat for the banks – a simultaneous reduction in MDR and an increase in policy rates – is unlikely,” said Syed Asad Ahmed, a research analyst at Foundation Securities, in a note issued to clients on Wednesday.

And if it was not for the IMF program’s conditions, which will spike interest rates, there is no indication of any desire on the part of the central bank to help out the banking sector.

Published in The Express Tribune, July 12th, 2013.

Like Business on Facebook, follow @TribuneBiz on Twitter to stay informed and join in the conversation.