Forcing to lend: Tightening the noose around banks to free up credit for private sector

Low interest rates have forced habitual lenders to go for more proactive revenue streams.

KARACHI:

The State Bank of Pakistan (SBP) is not a very popular institution when it comes to the government. It often does not see eye to eye with government officials especially because of its adherence to the code that the government should reduce domestic borrowing, so that bank credit is freed up for the private sector.

Having said that, the central bank is probably not very popular lately with the banking sector either, because the SBP has been squeezing its spreads (the difference between the rate at which banks lend and the rate they pay as interest on deposits).

For a long time the State Bank of Pakistan has implied, without saying so in so many words that controlling inflation through the interest rate mechanism does not seem to work in Pakistan, at least not in the conventional sense. One would wonder then why the central bank has persisted with its strategy of gradually lowering interest rates over the past one year or more and seems reluctant to reverse this trend even though inflation is once again on an upswing.

The biggest reason that has become apparent over the past year or so is the control of government borrowing on one hand, and to encourage lending to the private sector on the other. This has been rationale behind this approach, that if the SBP cannot force the government to stop borrowing (by increasing interest rates) then it can make it unattractive for the banks to lend to the government.

The central bank shifted this strategy after it realised that raising interest rates merely forced the government to borrow at shorter tenors. But decreasing interest rates seems to have worked, to a degree anyway.

For example the Domestic Markets and Monetary Management Department of the State Bank of Pakistan (SBP) did not receive a single bid at the auction of market treasury bills of six- and twelve-month tenors held on September 4. However, the central bank received bids of Rs87.9 billion for the three-month market T-bills.

One can deduce that if interest rates were lowered or at the very least kept at current levels, banks will continue to lose interest in bidding on T-Bills. Core interest income is falling and banks are beginning to feel the crunch. And why shouldn’t they? They have had it their way for quite a while and now they need to feel the crunch.

So, while this is one reason why rates should not be increased, it is also a good thing that banks are being finally forced to look at other avenues to invest their funds in, so that they can keep the revenue stream alive. That is basically what the banking system is for. It is not really contributing to the economy if the core income is from government borrowing or investing in government paper.

I personally think that the government should keep interest rates constant, if not lower them even further. This is in my opinion the only way to force the banks to stop lending to the government and start playing their due role in helping the economy grow.

The economy is slow. Banks can help it grow. Maybe now they will.

Published in The Express Tribune, September 9^th,  2013.

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