Facing a double-edged sword

There has been a lot of discussion among analysts and news media about the amount of liquidity in the market and with the banks since last week. After the bank financing rates fell to a level below the 3-month KIBOR rate, this discussion gained momentum.

This is unrelated to the declining rate of inflation, as banks are not hoarding additional liquidity that is generated from consumer deposits. SBP’s (State Bank of Pakistan’s) injections through open market operations (OMOs) are another significant source of liquidity for banks.

Analysts are linking this low-cost lending to the government sector in an attempt to raise the advance/deposit ratios (ADRs) of banks. Certain others believe that the purpose is to promote economic activity, among other things. This is really misleading.

As evidenced by the Rs 10.8 trillion in money injected by SBP’s OMO injection, there are severe liquidity shortages, which support this writer’s argument. However, the ADR will only increase by 3.4% even if the difference between bank lending and deposits is reduced by Rs 1 trillion. But in this writer’s view the fundamental reason for this action is that the SBP-mandated ratio was not maintained, which raises concerns about ADR compliance.

This may be the price banks are paying and will continue to pay in the form of fines for refusing to extend credit to the private sector.

Banks may be avoiding risk by not lending to the private sector because they can be concerned that lending at a record high KIBOR rate may lead to a spike in non-performing loans (NPLs). Investing in government paper that carries no risk is unquestionably the better choice.

However, the bank management and their Asset Liability Committee (ALCO) in particular is solely responsible for taking into account the risk element in investments of such a high magnitude.

SBP circular was published in the third quarter of 2021 informing banks that if they invest in government securities beyond the allotted amount, they will be subject to an additional tax of between 35% and 37.5%, depending on whether they allocate 50% or 40% of their ADRs. Originally, banks were expected to lend 50% of their deposits to the private sector.

The only two options available to banks are to either mobilise deposits or decrease the size of the deposit amount in order to reach the necessary ADR level and satisfy the SBP’s criteria.

However, banks are left with no choice after the deadline for meeting the target as time for getting exemption has passed, and those who did not achieve the threshold were expected to pay additional tax at a rate of either 10% or 16%, depending on the portfolio. It is a certainty that banks that don’t reach the SBP criteria before the allocated time, will have to pay the tax according to the rules. It is indeed a double-edged sword.

Copyright Business Recorder, 2024