Banking system woes: overnight rates as high as 40 percent

[Naveed Yaseen]

KARACHI (October 06 2008): The banking system of Pakistan is getting choked not on account of toxic debt but due to lack of liquidity. This has led to a situation in which some banks have started bouncing cheques of large amounts in order to retain funds with them. On Saturday, the overnight interbank lending rates (the rate at which banks lend to each other) touched 40 percent.

Confirmation of a bank borrowing at 40 percent was obtained by Business Recorder while unconfirmed reports of borrowing at 50 percent were also floating. With cotton financing season commencing from October 1st, banks are finding it very difficult to lend money for this purpose; unless additional liquidity is injected into the system either by way of retirement of loans extended to oil marketing companies, as well as some Independent Power Producers due to failure of WAPDA to make timely payments, and government reliance on banks to keep the lights on. Or, the central bank needs to reduce the Cash Reserve Ratio (CRR) by at least two percent from the present level of 9 percent. This could help inject around Rs 75 to 80 billion liquidity into the system.

The State Bank recently lent a helping hand to the government by allowing banks to lend to OMCs, on behalf of the government, by allowing this amount as eligible for Statutory Liquidity Ratio (SLR). However, this amount should not exceed five percent of SLR. At present, banks are obliged to maintain 19 percent of their deposits towards SLR in government securities.

The primary source of liquidity squeeze is said to be the depletion in country's forex reserves. As a result the net foreign assets have gone down by Rs 167 billion - as against a Rs 24 billion fall at same time last year.

In the first 11 weeks of the current financial year credit to public sector enterprises from banking system has expanded by Rs 53 billion while bank credit to private sector has gone up by Rs 29.3 billion. This is in addition to Rs 271 billion borrowed by the government from SBP itself.

Overall, borrowing by the government is said to be at Rs 116 billion and non-government credit has expanded by Rs 82.5 billion. The Net Domestic Assets of SBP have risen by Rs 73.2 billion. This is more than double of Rs 33.4 billion increase at same time last year.

In a rising inflationary environment, the SBP feels that any laxity in its monetary stance will further exacerbate the problem. Instead SBP favours a significant cut in expenditure coupled with banks striving for an incremental raise in deposits. The tight liquidity has resulted in KIBOR, once again, shooting up to 14.75 percent. All the banks have done is to cannibalise deposits from one another by offering higher return to big depositors.

SBP wants banks to attract deposits from Rs 1.2 trillion circulating as cash in the system or kept under the mattress. Banks on the other hand feel that these funds cannot be attracted at any cost as they lie in the grey market who would not like to be on the radar of tax authorities. They point out that despite a sweet offer to whiten these funds at two percent there has been very little inflow into regulated market from the black market.

According to experts, domestic liquidity needs to be generated through forex inflows and at present the system is short by at least Rs 80 to 100 billion of liquidity. The fallout of failure in the absence of quick corrective measures, say bankers, will render the non-bank financial institutions (NBFIs) as well as mutual fund industry non-functional.

In a rising inflationary environment and high commodity/raw material prices the needs of trade and industry have already gone up. The squeezing of private sector credit due to crowding out on account of high government borrowing could adversely affect exports. As it is, banks lose out on providing export refinance at 7.5 percent as their cost of funds has already gone up.

A proposal has been floated to allow banks to provide 30 percent of ERF from their own funds at the T-Bills rate. 70 percent of ERF is provided by SBP at 6.5 percent. This could result in the weighted average going up from 9.5 to 10 percent. This rate is still substantially lower than 16 to 18 percent being charged on loans to other bank clients.

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