Impending interest rate cut to drain depositor earnings
With the Central Bank (CB) cutting benchmark interest rates last week, secondary market rates began to drop from Monday setting the pace for financial institutions to slash deposit rates.
But the CB insists this move won’t erode depositors’ wealth.
C. J. P. Siriwardena, Assistant Governor – CB told the Business Times that the actual measurement is on the ‘real interest rate’ and that if this is positive, the depositors won’t get a raw deal.
“The real interest rate is the rate of interest an investor expects to receive after allowing for inflation. For an example, annual Treasury Bill (TB) rate is now about 11.5 per cent and the inflation is estimated for this around 7.5 per cent. When you deduct the rate of inflation from the TB rate, a depositor will get about 4 per cent as the real interest rate (per annum). This is a positive interest rate. If this goes in the other direction, where the TB rate is lower than inflation, then people will get a negative real interest rate. This is when their wealth corrodes and not when the real interest rate is at a positive rate,” he said.
Bankers say the CB’s deposit rate cut, which will reduce banks’ cost of funds, will enable the lenders to bring down their base rates, too.
Anil Amarasuriya, CEO Union Bank said with deposit rates reducing, a similar reduction on the lending rates should also occur which will trigger growth in credit which was seen in 2011. “As long as borrowers use money for income generation through business activities, then inflation will slow down and economic growth will accelerate,” he said.
As at last December, there were Rs 2.14 trillion worth of deposits in savings and fixed deposits. “I solely depend on the Rs.13,000 that I get from my savings account as interest. If the rates are reduced, I will find it very difficult,” W. Jayalath, a pensioner, told the Business Times.
A Sampath Bank official said that while an interest rate drop will badly affect depositors of whom a considerable amount are pensioners, the business community’s borrowing costs will be reduced. “Theoretically the prices should also come down when borrowing costs reduce and this should accelerate loan growth.”
He said that all lending rates won’t be re-fixed. “Existing fixed interest loans such as for housing loans, pawning, leasing, etc, won’t be changed,” he pointed out. This is not good news for the existing customers, as their rates won’t reduce, but it’s an advantage for new customers, he added.
Finance companies who are making hefty margins on deposit mobilization say that a deposit rate cut will be a blow below the belt. “There will be a major drain on deposits and our volumes will drop,” a finance company official lamented. He said that with all the odds they face, this will be the biggest.
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