Opinion: The Capital Market Cure

This cap though has not yet resulted in a lowering of lending rates. Banks have used the benefit of the intervention reducing the interest paid to the saver and kept lending rates higher than the benefit accrued. In other words, net interest margins have widened.

The Average Weighted New Deposit Rate (AWNDR) declined by 266 bps from end April to 8.58% in July 2019 and the Average Weighted New Fixed Deposit Rate (AWNFDR)declined by 269 bps from end April to 8.88% in July 2019.

This is as Average Weighted Lending Rate declined by 25 bps to 14.22% in July 2019 from end April and Average Weighted New Lending Rate declined by 74 bps to 13.88% in July 2019 from end April. Average Weighted Prime Lending Rate (AWPLR) declined by 147 bps to 10.77% as at 16th August compared to 12.24% recorded at end April 2019.

Like Moving Averages

The figures quoted for average weighted rates behave in the manner a moving average would. The figures quoted for new deposits or lending would only have an impact in proportion to their weight in the existing stock.

These averages are what the Central Bank has strongly signaled that it is trying to improve.

Are Banks Profiteering?

It, however, isn’t fair in this context to label bankers as being profiteers. Banks have an existing liability stock, i.e. fixed deposits made in 2018 and earlier, and this holds steady their cost of funds.

The Average Weighted Deposit Rate (AWDR)for Aug 2019 (based on July data) declined by 24 bps from end April to 8.73%. Average Weighted Fixed Deposit Rate (AWFDR)for Aug 2019 (based on July data) declined by 41 bps from end April to 10.74%.

Banks in Sri Lanka only offer instruments with fixed rates of return. Old deposits will still have to pay the rate of return negotiated earlier until such time that they are up for renewal. This means that even if all competitors are by regulation limited from offering high rates it will take time for that to impact their cost of deposits.

Banks as Victims

Banks have also in the recent past been on the receiving end of multiple tax increases. In the opinion of many, this is because banks tend to be highly compliant with the law and as such prove an easy target.

This regulation on net interest margins and thereby profitability comes as the banks have to raise considerable amounts of capital to be BASEL compliant. The Central Bank has set time spans and intermediate capital requirements for BASEL compliance.

Savers will probably end up diverting funds to risky commercial paper made available through a weak and expensive offering of unit trusts. Their rates are not regulated. This will reduce the growth of deposits with the formal banking system.

Given better capital markets savers would opt for corporate debt. However, the CSE and the SEC seem determined to prevent any such option from developing.

Private Credit Growth Has Contracted

 If total credit does not grow sufficiently and existing lending obligations are not repriced, then average weighted lending rates would not decline to the 200 bps target. This would happen even if the banks lend at rates agreeable to the regulator.

Here there is the opportunity to game the metric. Banks and the regulator can collude by charging high fees on the repricing of obligations. At the same time, they could bring down the interest rate.

To quote the recent monetary policy statement;

Private sector credit in absolute terms, declined marginally by Rs. 1.2 billion in July 2019. This is after a significant increase of Rs. 63.2 billion in June 2019

The cumulative increase during the first seven months of 2019 is Rs. 42.5 billion.

Year on year growth of credit further moderated to 7.7% in July 2019 in comparison to 8.7% in June 2019. This is the lowest growth rate witnessed since December 2014.

Both the governor and director for economic research, Dr. Y M Indraratna called for concern with the reduction in private credit growth.

Capital Limitations

As earlier mentioned the situation is dire and therefore any fixes must be implemented quickly. The situations must also be plausible given the PESTAL factors of the country.

Objective

The objective of this strategy would be to free up the balance sheets of the banking system to make new loans. This would be a scenario wherein the banks and the regulator win. Further given the tax structure it would be beneficial for banks to make more money from fees than they do in the spread of lending and borrowing.

Securitization

Securitization is the process of parceling future revenue streams and selling them. Securitization became more well known outside the world of finance following the 2008 global financial collapse and the notoriety of mortgage-backed securities.

In a Local Context

Given the nature of our capital markets, securitization to third parties is not an immediate possibility. However, most major banks own finance companies. Notably, Peoples bank owns Peoples Leasing Company and Bank of Ceylon owns Merchant Bank of Sri Lanka.

These two institutions can take on the loans of their subsidiaries to the extent that they optimize their figures against the regulatory capital requirements. It would be wise to ignore the internal political implications between top management and those subsidiary companies. This is because if you had space to lend at lower margins the Central Bank has signaled that it would force you to do so.

Why Finance Companies?

Though our Central Bank may not want to admit it, the NBFI sector is the lifeline to the SMEs. This is where credit growth for the expansion of GDP can be most effectively stimulated.

The banking system is reflective of power in society. To whom loans are disbursed and at what rate are for the most part decided within those institutions. These assessments can have self-fulfilling impacts on creditworthiness. In certain instances, it is easier for some people to get lifestyle loans that they are unlikely to pay back than it is for businesses with strong track records to borrow to expand.

That is because banks may collateralize a Colombo home and not so one in Kandy. This invariably has an impact on liquidity for the Colombo residential market over Kandy.

Bob Hope said; 

A bank is a place that will lend you money if you can prove that you don’t need it.

Prime borrowers are the people who get the Average Weighted Prime Lending Rate. This rate has dropped the most according to the monetary policy data. This is because these borrowers have bargaining power with the banks.

Banks, if forced to lend on a short term time horizon, will probably do so by helping big companies refinance their negative cash flow positions. This would also help reduce their immediate default risk allowing management to postpone any difficult questions. Some large corporates have quite sizable negative cash positions.

This would not Result in investment

Given above are the cash flows of the three leading diversified holdings groups in the country. No one invests during election season. Note that Melstacorp’s investment figure for 2019 is linked to its takeover bid on John Keells and not really linked to new investment in the economy.

Big companies are in a position to plan their investments in line with government policy. They, therefore, wait to see who the government is going to be and what they plan to do. They do not want to be in a position where their investments go against government policy.