According to the latest data released by the State Bank of Pakistan, the spread between deposit and lending rates has shurnk by 54 basis points to 7.11 percent during the first 10 months (January to October) of the current calendar year from 7.65 percent in the same period last year. This was stated to be the lowest 10-monthly average banking spread during the last seven years. The change in the banking spread rate occurred basically due to a sharp reduction of 75 basis points to 12.91 percent in the lending rate while deposit rate was also lower by 20 basis points at 5.8 percent despite an increase in the minimum deposit rate on savings accounts during this period. On a month to month basis, the picture was even better. During October, 2012, banks' average spread was at 6.77 percent compared with 7.67 percent in October, 2011, down 90 bps primarily due to 125 bps reduction in the lending rate.
The reasons for an appreciable reduction in the banks' spread are not difficult to seek. While deposit rates in Pakistan are relatively sticky, lending rates usually follow the trends in the discount rate determined and announced by the SBP in its monetary policy statement after almost every two months. Since the policy rate had declined by 400 basis points in the last two years, the lending rate has followed similar trends though the extent of reduction between the two was somewhat dissimilar.
Kibor, for instance, stood at 11.3 percent during July-October, 2012 as against 13.6 percent in the corresponding period last year, indicating a decline of 2.3 percent. Another factor responsible for the fall in the lending rate was a sharp increase in investment in risk-free government securities by banks, which earned lower rates than credit disbursement to private sector at a higher rate with an element of risk. Such a shift in asset portfolio of banks was facilitated by ample availability of government securities in the system due to a widening fiscal deficit and government's inability to finance this deficit through non-banking sources. Banks are satisfied with the present situation because their overall earnings are likely to maintain an upward trend due to the possibility of lower provisioning in future because of higher percentage of risk-free assets in their balance sheets.
However, while the latest trend in banks' spreads would apparently appear to be a desirable development, its overall impact on economy needs to be interpreted with care in Pakistan. This is so because the narrowing of spread was not basically due to the improvement in efficiency in financial intermediation by banks but was the result of factors which provided an opportunity to banks to disengage themselves from their traditional functions and make hay while the sun shines without much effort. In fact, shift in preference in favour of government lending by the banking sector is retarding the growth of private sector credit and negatively impacting economy. In its recent reports, SBP has repeatedly advised banks to re-examine and improve their lending protocol and financial intermediation process, but it would be futile to expect a major change unless the fiscal authorities of the country do not reverse their expansionary stance by adopting stringent measures.
It also needs to be pointed out that since the real average deposit rate (adjusted for inflation) continues to be highly negative, households are not likely to change their saving behaviour, with the result that saving rate of economy would continue to remain largely unaffected. This suggests that savers and investors in private sector would remain largely indifferent to the trend in banks' spreads unless and until fiscal policy of the country, and overall behaviour of banks, in particular, their efficiency in financial intermediation would not be able to show a perceptible improvement.