Commercial banks this week reduced their borrowing and some part of their lending rates in line with calls by the Central Bank to cut rates but credit demand hasn’t risen as one would have expected, banking sources said.
One banker said the demand for credit is still on the low side. “Banks are careful in lending because of the high percentage of non performing loans and many others defaulting in repayments,” he said adding that, the low interest on deposit could also see a shift in investors to finance companies.
In a bid to stimulate credit demand and increase economic activity after the end of the conflict, President Mahinda Rajapaksa ordered state banks last week to cut rates to between 8 to 12 % with the commercial banks also requested to follow the trend.
Sources at a state bank said there were loan applications coming in and these would take a few days for processing and eventual approval. “There is a small movement in demand but our worry is also whether depositors particularly pensioners would move their investments back to finance companies owing to the low rates,” one source said.
During the crisis that plagued the finance companies earlier this year, triggered by the collapse of Golden Key and other finance companies coming under the Ceylinco Group, many depositors shifted their investments to state banks preferring a lower rate of interest in a more reliable institution. However with interest rates coming down to far less than 10 %, investors are at a wits end as to where to put their money when real inflation is not in sync with government-announced rates, one desperate investor noted.
In a related development, the Central Bank said on Thursday that interest rates are expected to reduce in finance and leasing companies, resulting in an increase in economic activity.
In a statement, it said in line with current trends of easing interest rates, lending rates of these financial institutions are expected to call in coming weeks.
“Such a reduction would benefit entrepreneurs in industry, services and agriculture sectors, in particular small and medium scale businesses.
At the same time, the leasing, hire purchase and other lending volumes of registered finance companies and specialized leasing companies would increase as a result, thereby contributing to improve economic activities in the country,” the bank said.
Meanwhile a top fund management specialist said lower interest rates are a double edged sword, bringing along some good and some bad depending on whether people are borrowing money or depositing money in banks.
The slashing of interest rates will be beneficial for borrowers and traders in the short run but the depositors and entrepreneurs will not get benefits out of it in the long run, according to Chairman of Wealth Lanka Management (Pvt) Ltd Mangala Boyagoda. He told the Sunday Times FT that this action is aimed at encouraging banks to lend money and for consumers to spend to increase the money circulation in the country. In general, as rates fall, the price of a fixed bond will rise, and vice-versa, treasury bills bonds and other fixed-income investments pay a fixed-rate of interest for a certain term, after which the principal is returned.
These instruments are bought by risk-averse investors, those simply seeking a safer return on a portion of their investments as part of an overall asset allocation strategy, or those simply needing income. Under this set up the reduction of interest rates on bank loans cannot be sustained in the long run as it will affect the operations of banks and financial institutions.
On the other hand, he noted that, if foreign investors who have invested in dollar bonds decide to cash in their bonds the country will face a foreign exchange problem, he said.
Citing an example he noted that “if a foreign investor who bought 2013 bonds worth Rs. 100 million with a coupon rate of 13.5% at a price of Rs. 101,236200 three months ago, he can sell the bond today at a price of Rs. 109,738,700 with the 13% interest.” The foreign investor can earn a sum of Rs. 8.5 million or 33.8% under this set up without paying any taxes, he said. On the other hand local investors have to pay 25% tax for similar transaction. “This is one of the dangerous aspects in the reduction of interest rates,” he added.
In the meantime he welcomed the Central Bank’s initiative of starting auctions of dollar swaps to withdraw excess domestic currency liquidity in the market. He said that the move to sell Central Bank’s portfolio of government treasury bills to absorb rupees generated from dollar purchases will help to strengthen the economy.