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Interest rate cuts for
Economic activity not consumption

The interest rate cuts imposed on state banks by the government is applicable only for loans taken for economic activities and not for consumption, and while lending rates are down, deposit rates would remain as they are, a senior official of a state bank says.

"The eight percent interest rate would be applied to loans granted for those sectors creating economic activity such as agriculture, fisheries and SMEs other than consumption," General Manager of the Bank of Ceylon, B. A. C. Fernando told the Island Financial Review.

"Interest rates on loans for such activities would range between eight and 12 percent as requested by the government," he said.

Fernando said state owned banks have reduced their lending rates in a bid to boost economic activity but deposits rates would not be reduced.

"Lending rates have been significantly lowered but we are leaving deposit rates as they are. We are not focusing on deposits right now but providing the necessary stimulus the economy needs by way of credit," Fernando said.

He said interest on loans for consumption purposes would remain unchanged.

"However, as time goes on we could see lending rates reduce across the board," Fernando said.

Last Tuesday, President Mahinda Rajapaksa met with heads of state owned banks and directed them to reduce lending rates to 8 to 12 percent, stressing the need to extend this benefit to existing borrowers as well.

State banks are now expected to notify existing borrowers their revised repayment schedules based on the lowered rates of interest.

State-owned banks have been directed to refrain from charging penal interest rates, relaxing collateral security requirements and reduce late interest charges on delayed loan repayments.

These directives have been implemented with immediate affect with special attention to the credit needs of the agriculture, fisheries, tourism, construction and SME sectors and would be revised end November 2009.

Dealers  sceptical...

Private sector commercial bank dealers said their banks would have to follow suit and reduce rates, but not the extent state-banks have been made to do so.

"Private banks have to pay taxes amounting to about 60 percent of profits, give decent returns to shareholders, pay staff salaries and set aside provisions for bad loans out of profits. In Sri Lanka, banks have to maintain a six percent margin between average lending rates and deposit rates in order to meet these commitments.

"So if lending rates are coming down to 12 percent, long term deposit rates would have to come down to 6 percent," a dealer said.

Dealers said this was a short term political measure adopted by the government.

"It could stimulate the economy but it cannot be sustained for long, perhaps for another six months," a dealer said.

Without reducing deposit rates, slashing lending rates could lead to a skewered balance sheet where assets are over and above liabilities—more loans than deposits.

"If this is a short term measure then state banks would probably not suffer much given their huge volumes and financial size," a dealer said.

"If private commercial banks do not follow suit we could see a two-tiered financial market where the public would take their deposits to private banks where deposit rates are high and borrow from state banks where lending rates are low. This model cannot be sustained," he said.

A matter of  lending...

The Central Bank has reduced policy interest rates, removed penal interest rates and the statutory rate reserve since the beginning of the year in a bid to boost the creation of credit. Private commercial banks have responded slowly but not to levels the Central Bank would want them to.

Private commercial banks are also cautious in their lending and prefer to invest their excesss funds in government securities rather than lend.

Central Bank shows that net credit to the government has increased by 90.7 percent from Rs. 399.9 billion as at July 2008 to Rs. 762.6 billion as at July 2009.

Credit to the private sector, on the other hand, has declined by 2.1 percent to Rs. 1.203 trillion from Rs. 1.229 trillion. Net credit to corporations increased by 2.1 percent to Rs. 44 billion.

"State owned banks have huge amounts of exess liquidity. They could park these at the Central Bank at 8 percent (repo rate). But if they lend at anything between 8 to 12 percent they could make a slightly better return and stimulate the economy at the same time," a dealer said.

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