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Raising CRR: A clear signal for major rate hike in near term

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November 17, 2021 (MLN): In a recent development, the State Bank of Pakistan (SBP) has taken a move that will slash the lending capacity of the banks and contain aggregate money supply growth as SBP raises the statutory Cash Reserve Ratio by 100bps to 6%. While the daily minimum CRR has also been increased to 4% from 3%.

Market participants opine that this will address concerns with regards to a major rate hike in the near term. Arif Habib Limited (AHL), in its report, highlighted that the decision comes as a clear signal that the central bank will be using a mix of its quantitative tools to address the growing concerns on money supply, inflation and other macroeconomic indicators.

To highlight, the step is a continuation of SBP exacting conditions for auto financing which had grown to an all-time high level of PkR338bn as of September, reflective of ensuing demand-side pressures.

The CRR is applicable on demand liabilities and time liabilities with a tenor of less than a year. As per the data, total deposits of the scheduled banks stood at Rs19.8tr as of September’21 and as a result of this adjustment, an additional of around Rs160-Rs170bn is likely to be parked at SBP. This means liquidity available to the banks shrinks as banks will be deprived of 1% of their deposits which they would have either lent or invested to generate revenue.

To recall, CRR has been kept stable at 5% since 2008. After having it increase from 7% to 9% in 2008 to slow down money supply growth, it was reduced to 5% in 2012 to boost the economy. To note, in FY08 money supply growth was 10.9% against 16.3% in FY07. Currently, it stands at 11% CYTD.

Pakistan’s money supply growth since COVID has surpassed the historical annual growth rate of 12.0%. Since Mar’20, the average growth in money supply relative to the previous year stands at 16.7%. This reflects higher cash withdrawals by depositors to meet needs amid pandemic. Moreover, cash distributing schemes amid Covid-19 as a relief measure can also be considered as a significant contributor to the money supply growth.

As per the market participants, the most plausible impact of an increase in CRR is the lowering of loanable funds available with the banks. This, in turn, would limit the monetary expansion by slowing down lending. Resultantly, inflation is anticipated to come down, which currently is hovering at 9.2% (Sep’21) and the pressure on PKR is also likely to be reduced.

However, in a system where almost 30% of the overall money supply is ‘cash in circulation, the effectiveness of the CRR tool might be challenged. Out of the Rs27.86tr money supply circulating within the economy, Rs7tr is the currency in circulation. Also, with rising interest rates and CRR hike, banks are likely to charge higher rates on advances, which will impact the overall private sector credit-offtake which currently stands at Rs226bn (July-Oct 21), senior analyst Sana Tawfik at AHL said.

Meanwhile, Abdul Rehman Siddiqui, an analyst at BMA said that while banks are consistently striving for low-cost deposits and improving their CASA ratios, we do not opine that banks will go out and add higher costs deposits just to gage the additional reservation requirement. If that turns out not to be the case, then we can expect interest expense to increase and hence a slight reduction in NIMs.

Moreover, to counter any negative earnings impact, banks will likely seek to add up deposits of longer tenors where the CRR is not applicable. Just to recall, banks are already penalized with an additional tax charge of 2.5% and 5.0% on income from debt securities if ADR falls below 50% and 40% respectively. That said, given this requirement, the said targets (maintaining ADR over 50%) become a little more stringent for banks to meet, he added.

Besides, the recent measure to integrate government accounts into a Single Treasury Account (TSA) is already a concern for banks which is expected to put further pressure on the overall liquidity of the banking sector with government treasury deposits moving from banks to the SBP.

Nevertheless, the SBP is confident of a positive impact of the CRR hike as the banks would be encouraged to generate more deposits to cope with additional liquidity requirements for their operations. As a result, banks would offer better returns on deposits to attract funds; thus, serving the SBP’s objective of encouraging savings.

On the profitability front, the impact of increasing CRR would be compensated by improvement in Net Interest Margins, as the monetary tightening cycle has just started and almost all banks have structured their balance sheet for a rising interest rate cycle by reducing the duration of investment portfolio towards shorter maturity.

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Posted on: 2021-11-17T10:23:25+05:00

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