THE State Bank of Pakistan’s twin decision to reduce the discount rate by 100 basis points and introduce a ‘target rate’ within an ‘interest rate corridor’ can best be described as commercial banks getting doused with icy water after a long night of partying.

And while trade and industry bodies have welcomed the move, bank investors are left scratching their heads. They know that banks have had an unusually good ride of late courtesy the change in the source of the government’s borrowings.

Unsurprisingly, most bank stocks hit their lower price circuits last Monday; however, many of them had regained some lost value amid hopes that credit offtake will pick up as the China-Pakistan Economic Corridor projects start materialising.

Yet, the biggest beneficiary of the rate cut will not be the private sector, but the government. During 10 months of this fiscal (till May 8), the government had borrowed a huge Rs1.13trn from commercial banks. During the same period, banks lent a measly Rs161.7bn to the private sector, down from Rs292.9bn in the same period of the last fiscal.

Some industry watchers have termed the introduction of a target rate by the SBP, and its stated intention of keeping short-term money market rates close to this rate, as a belated but appreciative step that will act as a wake-up call for banks, possibly pushing them to increase their private sector lending.

IRC: The central bank announced that it has set a new ‘target rate’ 50 basis points (bps) below the ceiling (or deposit) rate. It also reduced the width of the interest rate corridor (IRC) by 50bps to 200bps. For the next two months, the ceiling will be at 7pc, the target rate at 6.5pc and the floor at 5pc.

The ceiling is the rate at which banks borrow funds from the SBP’s overnight discount window, while the floor is the rate that banks get on the surplus funds they park with the central bank.

Banks’ net interest margins will be squeezed from both the lending (income)

and deposit (expense) sides

In a document issued in February, the central bank had indicated that it was contemplating altering the existing IRC and introducing a target rate.

“The main objective [of the IRC is] to minimise volatility in the money market by ensuring the movement of short-term interest rates within a reasonable range. [It is] aimed at strengthening the transmission mechanism of monetary policy to achieve the ultimate goal of maintaining price stability,” it said.

One reason the transmission of monetary policy was slightly hampered over the past couple of years was the reported misuse of the discount window by banks.

“Central banks across the world act as the ‘lender of last resort’ for their banks. But here, banks took advantage of the facility by borrowing from the SBP’s discount window and then parking the funds in longer tenured government debt; making easy money from the spread,” explained one source.

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