Decline in banking spreads has raised serious concerns for the banking industry following the reduced interest rate scenario coupled with changes in the MDR (Minimum Deposit Rate) has taken its toll on banking spreads that clocked in at 5.19% in December 2015 (down 9bps/83bps MoM/YoY), lowest since January 2004. More profound impact was seen in fresh spreads that tumbled to multi year low of 2.7% in December 2015 (down 59bps/161bps MoM/YoY) owing to year end phenomenon.
"We believe the delayed pick-up in inflation is to keep the interest rate low and thus, sector's earnings would remain subject to reinvestment risk," experts said.
As per the latest SBP's numbers, banking spreads further declined to 5.19% in December 2015 owing to a drop in lending rates by 10bps/225bps MoM/YoY to 8.67%. Deposit rates also followed suit (witnessing an attrition of 1bps/142bps MoM/YoY to 3.48%), however, decline was not enough to compensate for the drop in lending rates.
In CY15 average spread stood at 5.56% versus 5.99% in CY14, down 43bps and is the lowest average in last 11-years. During December 2015, fresh spreads were down by a hefty 59bps MoM (versus 9bps decline in outstanding spreads) to 2.7% on account of a sharp surge in deposit rates (up 55bps MoM) and a meager decline of 4bps MoM in lending rates. We believe sharp increase in deposit rates is a result of aggressive marketing by the banks in order to accumulate high deposits for the year end. Hence, we expect deposit rates to normalize in ensuing months.
On the balance sheet side, the year saw growth in deposit (11.5% YTD), which compares favorably with 10.8% growth witnessed last year but a notch below 5-yr average growth of 14.1%. The incremental deposit flow remained directed towards risk free government papers (up 32% YTD) with subsequently pushed the IDR up to 72%.
Advances seemed to be a secondary choice of banks which portrayed a meager growth of 7.3% YTD translating into an ADR of 51.4% in CY15 (versus 53.4% in CY14). Lower growth in the advance is also attributed to lower working capital requirements due to lower commodity prices. Delayed pick-up in the inflation (read our report MPS: Prudence advocates a wait and see approach dated 20th January 2016) has considerably weakened the case for rate reversal before June 2016. Hence, the reinvestment risk can prove to be a drag on the sector's profitability going forward.