COVID-19: Banks take a hit on their spreads, lowest since April 2019

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KARACHI: Pakistan’s banking sector spread fell by 33 basis points on a month-on-month basis to 5.37pc in February 2020. This is the lowest figure since April 2019.

Bank spread refers to the difference between the interest rate that a bank charges a borrower, and the interest rate a bank pays a depositor. The bank spread can be thought of as a percentage that shows how much money the bank earns compared to how much it can lend out.

Pakistan’s banking industry, particularly in the last year because of higher interest rates, has been characterized by high spreads and strong profitability.

But that is set to change due to the unprecedented COVID-19 crisis, according to Hamza Kamal, senior analyst, in a research report sent to clients by securities brokerage firm AKD Research on March 30.

The industry has lost 32.3pc since just February 26, which is when the first case of COVID-19 was diagnosed in Pakistan, following rapid emergency rate cuts.

In wake of the COVID-19 pandemic, the State Bank of Pakistan cut the policy rate by 75 basis points on March 17, from 13.25pc to 12.5pc. Then in an unprecedented move, the SBP cut the policy rate again just one week later on March 24, by 150 basis points to 11pc.

The rapid reduction in the policy rate, along with the decision to narrow the floor rate from 150 basis points below the policy rate to 100 basis points (so 10 percent), will negatively affect spreads. According to Kamal, just the change in the floor rate, leads to a 30 basis point reduction in spreads across banks.

On the bright side, recent SBP decisions to help borrowers under COVID-19 may have some short term benefits for bank spreads.

In its relief package for borrowers announced on March 26, the SBP also relaxed the regulatory criteria for restructuring of loans until March 31, 2021. Loans that are rescheduled within 180 days from the due date of payment will not be treated as defaults. This will help give some time to banks to fix non-performing loan issues in the short run, thereby helping with spreads.

Similarly, the SBP also reduced the capital conservation buffer (CCB) from the current 2.5 percent to 1.5pc. On a whole, this will allow banks to lend an additional amount of around Rs800 billion, an amount equivalent to about 10pc of their current outstanding loans. Again, according to Kamal, this decision will help banks absorb risk.

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