Banking spread shrinks to lowest in over a decade

Amounts to 5.34% in October, banks countering by investing in government securities

KARACHI:

The banking spread continued its downward slide in October, reaching the lowest level in over a decade, according to the latest set of weighted average lending and deposit rates released by the State Bank of Pakistan (SBP).

The banking spread is the difference between lending and deposit rates. The spread on outstanding loans and deposits in October clocked up at just 5.34%. The spread shrank by four basis points month on month, as it was 5.38% in September.

Shrinking spreads reduce banks’ profitability, as they pay a higher interest on deposits but earn a smaller return on advances. Banks generally respond to such a scenario by investing more in riskless government securities that offer guaranteed returns.

The banking spread has mostly been shrinking for the past one year in the wake of accommodative monetary policy by the SBP. The central bank has reduced the benchmark interest rate consistently since 2014, as it currently stands at a historic low of 6%.

However, most analysts believe the monetary easing cycle has bottomed out and that the benchmark interest rate will be on an upward trajectory now. The view is also reinforced by the latest monetary policy announcement in which the central bank maintained the status quo while forecasting an uptick in inflation going forward.

Banking profits should have taken a hit, at least theoretically, in the wake of shrinking spreads. However, banks made a combined profit of Rs148 billion in Jan-Sept, up a whopping 28.7% from earnings recorded in the same nine-month period of 2014.

In the wake of shrinking spreads, banks have chosen to support their bottom lines by investing heavily in government securities. While growth in banks’ mobilisation of fresh deposits and generation of new loans remained in the single digits during the first nine months of 2015, their investments surged by 26.4% over the same period.

The banking sector spread registered a decline of 47 basis points (0.47%) year on year in October. It had averaged 5.81% in the same month of 2014, SBP data shows.

The weighted average lending rate decreased 22 basis points to 8.96% month on month. According to Alfalah Securities analyst Fahad Irfan, the dip is because of successive discount rate cuts. The weighted average deposit rate dropped 18 basis points to 3.62% in October, SBP data shows.

Interest rates on loans are reset on a quarterly basis whereas deposits are re-priced immediately.

The banking spread on gross disbursements and fresh deposits during October - also called the ‘fresh spread’ - clocked up at 3.22%, up from 2.88% recorded in September. The weighted average fresh lending rate was down 21 basis points to 7.57% month on month while the cost of fresh deposits was down 55 basis points to 4.35% in October.

Published in The Express Tribune, November 26^th, 2015.

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