Kibor's credibility

There is no dearth of conspiracy theories in Pakistan. Motives could be attached to matters which are totally transparent. In a front page report supposed to be startling, a reputed newspaper (The News) revealed on 1st August 2012 that some of the largest banks in Pakistan were suspected of colluding to fix the Karachi Inter bank Offer Rate (Kibor) and manipulate other money market-related interest rates.
Purported to be based on interviews with former bankers and ministry of finance officials, it has been mentioned that "the big five banks operating in Pakistan are already involved in interest rate manipulation and work together to clandestinely influence the overnight rates, which enables them to lend to small banks at high interest rates." Since bigger banks have larger deposit base and lower mobilisation costs, they usually have liquidity in excess of their requirements which is lent to other banks at slightly over the discount rate. The average rate of lending in the money market on any given day is the rate advertised as Kibor and the banks then use this rate as a reference and structure their loans to businesses and consumers at rates above Kibor, depending on the creditworthiness of the individual or corporate buyers. As the biggest players in the market were operating as a cartel, the cost of borrowings was continuously rising, enabling banks to pad their bottom-line at the expense of the borrowers. Such a rigging was not just limited to the Kibor rate but had also spilled over in the bidding for government securities such as PIBs and T-bills. "The dealers set prices after checking with each other, which strictly speaking, constitutes insider trading". The reporter seems to have talked to a lot of people on the subject. Former Governor, State Bank, Dr Yaqub agreed that there was some level of distortion in the Kibor mechanism operating in the financial sector in Pakistan. Banks lend on higher rates but do not offer positive rates of return to depositors. "In order to earn higher profits, banks influence and determine market rates, especially the Kibor." A prominent economist, Meekal Ahmed said that the problem was the opaqueness of the process. Banks were engaged in anti-competitive practices and the SBP should ensure competitive environment and discourage cartelisation and monopolies with regard to interest rate determination.
In order to have a broader view, some senior members familiar with the working of the financial sector and other relevant stakeholders were also approached to give their input on the subject. None of the big five banks except MCB Bank was willing to comment on the issue. According to Qasim Nadeem, a senior officer of the MCB Bank, manipulating Kibor was nearly impossible. There was a mechanism to eliminate the highest and lowest rates while determining Kibor and SBP was doing a commendable job. Salman Shah, a former Advisor to the Prime Minister on Finance, contended that there was no concrete evidence of collaboration to manipulate, influence or rig interest rates. Ahsan Mehanti insisted that the central bank was on the right path to making the money market more stable and vibrant. Competition Commission of Pakistan asserted that interest rates fall within the regulatory purview of the SBP and it could only step in when the facts proved cartelisation. It was not prepared to act on the basis of hearsay.
In a statement issued to "The News", the State Bank defended the present policy by saying that "in order to prevent any manipulation of Kibor, the Financial Market Association of Pakistan (FMAP), in consultation with State Bank of Pakistan, had devised clearly defined rules and regulations to govern determination of daily Kibor. According to the rules, each contributing bank was obliged to deal at the two-way price it had quoted for a minimum of 20 minutes. "As the prices quoted by contributors are executable, this mechanism prevents banks from quoting out-of-market rates as any such effort may result in financial loss for that contributor bank." In order to further minimise the chances of a contributor bank rigging the rates, Kibor rate of any particular day was calculated after excluding the two highest and the two lowest prices quoted. "Persistent outlier" from the Kibor could also be booted out from the system by FMAP. A help desk was also established by the regulator to investigate complaints against Kibor contributor banks.
Most of the readers would be impressed by the hard work undertaken to prepare such an exhaustive report on a sensitive subject which was perhaps never explored earlier. It certainly goes to the credit of the reporter that he has talked to a number of professionals in the field and also got the viewpoint of the SBP, CCP and MCB Bank to make the story more balanced and comprehensive. Besides, all shades of opinion are reflected in the report with varying degrees of emphasis. However, while appreciating all these aspects of the report, we feel that such an account was uncalled for, especially in the absence of some solid evidence, and could soil the credibility of Pakistan's financial regime. Although the author has explained that the big banks in Pakistan were "suspected" of interest rate manipulation, yet the way the story has been highlighted tells the degree of conviction of the author in the authenticity of the report and the ease in which the rebuttal of certain experts and particularly the State Bank has been ignored. In all fairness, the story should not have been published after vehement denial by the central bank and lack of necessary proof to back up the allegations. It needs to be understood that Pakistan's financial sector is small and easy to monitor due to relatively closer relationship between the banks and the regulator which eliminates the possibility of a Barclays like episode being replicated in Pakistan. Besides, the rules to ensure transparency in the fixation of Kibor have been devised in a manner which could punish the violators severely in terms of financial losses and being booted out from the system. We need not repeat the in-built safeguards in the system but are convinced about their transparency and efficacy. In order to prove the allegation, the author should have quoted at least a single transaction which was suspicious. What Yaqub and Meekal Ahmed have said is also not enough to prove the accusation. They have talked in generalities while focusing on their old themes that the system was opaque and depositors were being exploited by the banks by giving them negative rates of return.
What we are really afraid is not exactly the veracity of the report though it was important but the negative perception which could develop after its publication about the integrity of the country's financial institutions, both domestically and the international level. At a time when most of the other institutions in the country already don't enjoy a good reputation, even a hint of waywardness or departure from the international norms by the banks could have severe consequences for the economy by discouraging the foreign investors further. Even the domestic investors could have doubts about the fairness of the system and worry about the high lending rates forced on them through the unholy collusion of the bigger banks. This is not to say that the financial system is perfect in every way in Pakistan. Bankers are often rightly accused of enjoying the free-ride of investing in risk-free government paper, making obscene profits at the cost of depositors and awarding outrageous perks and privileges to the CEOs while they should be focusing on deposit mobilisation and proper financial intermediation. However, to suggest that they are or could be indulging in the manipulation of Kibor is too serious a charge that it should have been fully investigated and confirmed beyond any doubt before it was considered worthy of publication.