Tighter liquidity may prompt banks to compete for deposits, pushing rates higher: ICRA Lanka

Tighter liquidity in the overnight money market is likely to persist, prompting banks to compete for funds putting upward pressure on deposit rates which have shown initial signs of ticking up since the Central Bank raised key interest rates in August, according to ICRA Lanka Limited. 

The liquidity in the overnight money market has remained negative since August 16, just days prior to the policy rate hike,  and the deficit hit over Rs.200 billion on September 01 when the banks’ mandatory reserve ratio hike went into effect as Central Bank absorbed nearly Rs.160 billion which otherwise would have been available for banks for lending. 

The money market ended last week with a deficit of Rs.134.34 billion. 

“Tighter market liquidity will be the new normal moving forward,” said ICRA Lanka in a note. 

“Banks may compete for funds pushing deposit rates higher, but we expect lending rates to be slightly stickier in the short term. In this context, private credit is likely to weaken,” the rating agency added. Amidst negative liquidity, banks disbursed Rs.134 billion in August as private sector credit, the most since 2015 and the Central Bank left their key policy rates unchanged fortnight ago, saying they neither want to dampen it nor stimulate it further, implying they deem it as a healthy credit level to support the recovery of the pandemic hit economy with no overheating. 

However, August is too early to gauge the behaviour of private sector credit in the subsequent months as lending rates didn’t have time to adjust to the policy rate hike and the subsequent statutory reserve ratio hike. Hence September would provide a better indication to the future trajectory of private credit. 

In any case, the Central Bank has assured to meet any gap in the overnight market liquidity at the standing lending facility window and has since provided daily liquidity in large sums at 6.0 percent to banks to meet their funding requirements.

For instance, during the week that ended last Friday, banks have borrowed between Rs.203 billion and Rs.248 billion a day from the standing lending facility.

There were some signs of the banks responding to the policy rate hike and the subsequent sharp increases in the government securities yields through their increases in deposit and lending rates. 

For instance, though lagging, the data for August showed that the banks’ average weighted new deposit rate and the average weighted new fixed deposit rate rising by 20 basis points and each to 5.19 percent and 5.35 basis points respectively from July. 

While these average data masks some individual bank’s moves and it has been over two months since the policy rate hike and one and a half months since the statutory reserve ratio hike, the most recent data could suggest some steep increase in deposit rates as there were banks advertising up to 6.25 percent for a one year term deposit lately. 

However, as investing in 1-year treasury bill earns the investor as high as 8.16 percent at zero risk, it’s only a matter of time for the banks to start catching up with the soaring treasuring bill rates. 

While the general lending rates are yet to meaningfully adjust, the weekly average prime lending rate, the rate at which the loans to the big corporates and the prime customers are given, mostly for short term where price has risen by 152 basis points to 7.23 percent by the end of last week since ahead of the August policy rate hike, indicates that the rest of the market lending rates could also follow suit, though at a modest level. 

While the rising lending rates would expand the interest margins of banks, it could slowdown the volume growth of the loans as funds become costlier for the banks and the loans become pricier for the borrower denting the appetite for borrowings.