Banking spreads hit hard

Just some months back, banks in the country were enjoying spreads of more than nine percent. What a pleasant, yet distant memory that must seem to the bankers that are now barely scraping spreads of 6.34 percent (as of May, 2013).
Central bankers deem higher spreads as a sign of poor financial intermediation and lack of competition in the industry. This is the core reason why the SBP introduced minimum rate on saving deposits in May 2008, which is still in place with further add-ons.
After the imposition of the floor rate on saving deposits, not only did the spread between lending and deposit rates fall considerably, but the gap between the discount rate and deposit rates which stood at 5.79 percent in May 2011, eased to 2.25 percent as of May 2013.
Besides, incessant rate cuts since July 2011, which held back lending rates, the SBP has also imposed other measures to curb spreads and to provide depositors with adequate returns. In April 2012, the central bank increased the floor rate on saving deposits by 100 basis points to six percent.
The impact of the directive is well evident by the spread between lending and deposit rates which fell by over 100 basis points over the year.
Yet another jolt came when the central bank issued another directive of calculating the profit on the average balance of saving deposits instead of minimum balance in April 2013. With the impact of this edict yet to fully materialise on the net interest margins of banks, SBP in its recent monetary policy held on June 21, reduced the policy rate by another 50 basis points to nine percent.
Banking pundits predict that the latest rate cut will result in 15-30 basis points decline in net interest margins for the banks. With banks already operating at margins never seen since 2005, the rate cut together with change in calculation methodology of saving deposits will increase the cost of deposits for banks. This might push banks to other out-of-the-box avenues, such as launching new low-cost products or tapping niche consumer markets.
On the heels of reversal in the monetary cycle most likely in CY14, the spreads of the banking sector might take a sigh of relief, if the floor on saving deposits remains at six percent. However, with the central bank keeping a close eye on banks earnings, the reversal in spreads seems relatively unlikely.