Commercial banks will end up reducing interest rates on loans following a directive by the President this week for state banks to slash their interest rates to levels between 8 to 12%. Speaking to the Sunday Times FT this week, Secretary General of the Bankers’ Association Upali De Silva said that although private banks have not been given any directives and cannot be compelled to reduce interest rates, they will have to follow suit to a certain extent.
Private banks will most likely take a common strategy in planning the extent to which they will reduce interest rates on loans. Mr. De Silva said that the portfolios of state banks, around 30% to 40%, are at higher rates of interest. “They will have to take a huge loss.”
Mr. De Silva added that private banks will have to reduce their margins and will need to cut the costs of their funds but they don’t have huge savings and current account balances that state banks do. Interest rates on savings accounts are between 4% and 4.4% while current account interest rates are 0%. He said state banks will have to cushion the impact due to their huge savings and current account balances.
The rate cuts were welcomed by industry across the board while depositors expressed concern as their income comes down by almost half. (See connected stories on Page 7).
Mr. De Silva said international interest rates are low but does not believe Sri Lanka’s interest rates will drop to global levels. There have been 0% rates in countries in the past such as Singapore and Japan but those are totally different economies to Sri Lanka’s, he explained. “Never in the history of banking have we come down to those levels.” However, he added that by ordering state banks to reduce their interest rates, the government most likely realized that other banks will be compelled to reciprocate.
Another senior banker told the Sunday Times FT that one of the reasons behind the government’s directive for state banks to reduce their interest rates was to get private banks to follow. He added that during the last few months, interest rates in the market came down drastically but lending rates did not follow. “This is also one of the reasons for the government to give its directive,” he said.
The banker added that fixed deposit rates, which were around 10% to 11% for 1 year this Tuesday, will also come down with the reduction of lending rates. He also predicted that treasury bond rates will also come down to create some stability in the market.
The banker explained that treasury bill rates have decreased tremendously since the beginning of the year, down to around 9% to 10% from around 17% to 18% in January 2009. When people feel interest rates will come down, they invest for longer periods, he said. If interest rates go up, people will invest for a shorter period. “With the sentiment over the past few months, people are investing in longer periods instead of shorter periods and have moved from treasury bills to treasury bonds,” he said. “People are going for longer periods because they expect the rate to come down to around 7% or 8%.”
Economist Sirimal Abeyratne said interest rates and inflation go together unless there is some intervention. He explained that even if inflation is high, interest rates can be controlled if the government secures public funds such as EPF and state banks to lend to them at lower interest rates. Furthermore, when there is high inflation, high interest rates can be used to control inflation through a reduction in credit expansion.
“Due to the fact that there is lower inflation now, interest rate can be brought down. That is why the Central Bank (CB) lowered policy rates in the past but commercial banks did not respond to it.”
If the government continues to borrow and spend in a big way as it did in the recent past, Dr. Abeyratne said obviously inflation can pick up again. However, he pointed out that the conditions attached to the International Monetary Fund’s (IMF) Stand-By Arrangement of US$2.6 billion requires the government to reduce expenditure and to restructure loss-making state enterprises which is proving to be a dilemma. |
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