HIGH BANK SPREAD IMPINGES ON ECONOMIC GROWTH

SHAMSUL GHANI (shams_ghani@hotmail.com)
Dec 21 - 27, 2009

Economic rationalization through high interest rate policy is more relevant to societies living on loans and mortgages. Our consumer finance and house finance levels never reached even a fraction of those prevailing in the developed economies. No doubt, during 2004-07 these levels rose a few notches up, yet the harsh policy of hiking the interest rate - in successive moves - from 7.5 to 15 percent was nothing but mindless implementation of text book theories.

On these pages, somewhere in the near past, this scribe wrote:

"We are a captive economy slaving away at the farmhouses of IMF, World Bank, ADB, and Paris Club. We continue to live under the illusion that we are an independent economy which [this illusion] is itself more dangerous than the actual captivity. We keep experimenting under the overseas directives without taking time out to mull over what we have been doing and what we ought to. Our economy has huge growth potential which has been proved through its occasional show of brilliance in the past. In the face of recent geo political crises, our economy performed well to the disbelief of many. We had a tremendous opportunity but could not get our acts together and dissembled into a woeful political and economic fragmentation."

These assertions become more relevant when seen in the light of following lines taken from the economic hit man, John Perkins' book:

"We both knew that the U.S. Treasury and State departments, in collaboration with the World Bank and the International Monetary Fund purport to help Third World countries pull out of recession; however they actually accomplish the reverse.

When these nations experienced economic problems and were unable to make their loan payments, they were forced to accept "structural adjustment programs" (SAPs) that mandated that client countries drastically reduce government spending, raise interest rate (often to 30 percent or higher), privatize sectors of their economies, and sell national assets to multinational corporations.

However, the most important criticism is that they DO NOT WORK. Or, restated, SAPs do not help the countries pull out of recessions. In fact, they drive them deeper into crisis. The proof: Geithner, Summers, Volcker, and friends -Obama's team - are urging the United States to adopt solutions to our recession that are completely counter to those imposed on the Third World: huge national spending programs, increased debt, reduced interest rates, bailouts and - the antithesis of privatization- government ownership of banks, automobile manufacturers, and other businesses."

The biggest beneficiary of interest rates' spikes has been our banking sector. In the age of falling interest rate, the banks swiftly brought down the deposit rates to average 2 percent or around, but when the interest rate started to go up, they never equitably readjusted the deposit rates. What was swiftly scaled up during that period was the lending rate. This gave rise to an anomalous bank spread which has not been rationalized till date. Gone are the days when the banking operations revolved around a decent spread of 3 percent.

The steep fall of State bank's discount rate gave bankers a reason to disproportionately reduce the deposit rates while leaving the lending rate to be determined by the market forces. As a result, the banks' profits soared and so did the prices of their shares on the stock market. The banks' balance sheets presented a rosy picture that was never sighted during the entire past.

The saddest part of the story is that the uncalled for accumulation of wealth in the coffers of banks took place with the active connivance of the State Bank which kept on making, for a greater number of years, polite requests to the banks to proportionately increase the deposit rates instead of coming down heavily on them in the capacity of a regulatory body. It was at a later stage when the Competition Commission of Pakistan took the banks by the scruff of their neck and the State Bank mandated a minimum five percent saving deposits rate.

The spread that was touching the double digit level has now come down to seven plus and appears to have stabilized at that point. During a period of one year, ending September 2009, the spread has come down by just 0.11 percent.

BANK SPREAD DURING ONE YEAR

PERIOD AVG. LENDING RATE % AVG. DEPOSIT RATE % BANK SPREAD %
Sept. 2008 13.34 5.85 7.49
Sept. 2009 13.67 6.29 7.38

An exorbitantly high bank spread tends to drive the wealth of common man into the bank coffers giving rise to unhealthy wealth concentration on one hand and making dents in the disposable income of masses on the other. So, one attribute of a high bank spread is its inflationary power. Further, an unusually high bank spread results both from low deposit payouts and high lending rates. High lending rates in turn depress the economy and stifle growth.

So, its recessionary force is yet another attribute of a high bank spread. The excessive wealth accumulated on banks' balance sheets has a number of uses. In the case of foreign banks, it is repatriated to the base country. In the case of local banks, a portion of it is utilized to oblige the corrupt and powerful segment of the society, in the shape of huge loan write-offs. Another portion is swallowed by the top brass of the banks, in the shape of high salaries, bonuses, perks etc. Of late, the difference between the salaries of top financial executives and rank and file has widened to an unbelievable extent. In United States it is currently 531 times. Since our financial sector culture has its roots in US financial systems, one can easily infer what the size of top bank executives' remunerations could be.

This is time about someone does something to cut this lethal economic deflator -high bank spread- to its normal size. Who is going to do that, the SBP? Certainly not, as it has defaulted on this account since the very inception. Who else, the rejuvenated Competition Commission of Pakistan? May be!