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by Dinesh Weerakkody

According to analyst the government's attempts at reducing bank spreads have met with limited success. They say what needs to be done is to remove the banks stranglehold on the financial system as the sole provider of finance. A strategy would be to develop the corporate bond market on a priority basis. In Sri Lanka as we all know banks make too much of profit because of their healthy margins. Banks quite naturally make their profit by borrowing at very low rates currently around 7 per cent and lending their money at very high rates, currently retail lending is around 15 per cent.

Such a huge disparity in interest rates are unique only to Sri Lanka and that is why banks in Sri Lanka occupy that enviable niche in the business sector in Sri Lanka where high profits are guaranteed, come what may. This is quite evident in the Business Today top ten rankings, where 5 of the companies ranked in the top ten were either banks of DFIs. Therefore the government's move to get banks to cut their lending rates in line with improved monetary and macro economic conditions is a step in the right direction. The time has come for the government to exercise a much more positive role in regulating banks and banking practices because stable low and stable interest rates are critically important to facilitate economic growth and development.

However, implementing this through legislation or interest rate controls may not be the answer. On the other hand conventional wisdom was that a higher number of banks would ensure competition resulting in lower rates and better service. This is however not true beyond a point, because the additional cost of running all these banks have been passed on to the public. Therefore, the government may need to facilitate a process to force banks to improve efficiency rather than follow the path of least resistance and also to increase the banks capacity to manage risks.

Decline in rates

Despite the recent decline in the Central Bank and Government Treasury Bill and Bond rates the interest charged by the commercial banks to their corporate and retail customers have not declined sufficiently to enable business recovery and future growth. A recent study done by a group of SMEs indicates that banks still charge rates as high as 17 per cent - 18 per cent for retail customers and 10 per cent - 14 per cent for corporate customers. The Minister of Finance according to sources has made several requests to the commercial banks to reduce their lending rates by operating on smaller margins but the response has been limited. There is a general perception in the market amongst customers that the banks are operating on unreasonable margins.

The banks have however pointed out that they are severely affected by the high cost of technology and the high percentage of non-performing loans. The interest spread of a bank represents the difference between the average interest rate earned and the average interest paid on funds. The spread covers the reserve costs, provisioning costs on non-performing loans, operating costs and profit. An examination of interests spreads in the market reveals that private commercial banks are operating on spreads as much as 5 per cent - 6 per cent whereas in other markets in the region the spreads are as thin as 1-3 per cent. The global benchmark is around 1-2 per cent. According to our research banks are still inclined to keep their customer lending rates high in order to cover their high loan loss provisioning, high administration costs and profit margins. This is representative of an inefficient financial system. The more efficient private commercial banks are in fact reaping record spreads and this includes a number of foreign banks.

This is why some of our top commercial banks make more than 20 per cent, when some of the well-managed banks in the world only make around 12 per cent. The State and domestic banks in particular are carrying cost-income ratios that are far too high. The banks are defending their case for thick spreads on the basis of 'costs' including administration costs. Effectively speaking, customers are paying for the inefficiencies in the banking system.

In the final analysis reductions in the lending rates to the commercial sector and also to the retail sector are essential to develop our industrial sector and our country. So it is high time our banks realise that it does not function in a vacuum and that its success is dependent on the fulfilment of certain obligations to society.

While we all agree that one basic responsibility, which the banks owes to itself, is to ensure its own survival. It can do so vigorously by demonstrating its contribution to national welfare. In addition it should propagate and publicise its contribution to society, which it has seldom done, and the saying that wealth created by the private sector is consumed by the public sector is little known, appreciated or believed by the public.

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