The Competition Commission of Pakistan (CCP) is trying to find out what led primary dealers (banks eligible for participating directly in auctions of government debt papers) to demand far higher than normal interest rates in some past auctions of T-bills. And, more worryingly, why the bids of some of them were identical — or very close to each other.

When banks participate in T-bills auctions they are free to demand whatever rates of return they think are reasonable. The State Bank of Pakistan (SBP) accepts or rejects banks’ bids keeping in view the government’s announced targets for borrowing during a certain auction and the impact of bids’ acceptance or rejection on liquidity in the interbank market.

Keeping the interbank market appropriately liquid is necessary to help the government and the private sector borrow at “appropriate” rates within the prevailing monetary policy regime — and to enable banking companies to continue to deploy funds for sustainable gains.

What has prompted CCP to initiate an inquiry into banks’ behaviour in past T-bills auctions is that in these auctions banks bids’ were too pricey. From September to December 2021, the average difference between the SBP’s policy rate and the cut-off yield for 3-month T-bills rose to 114 basis points. Since T-bills are risk-free, their yields generally remain 25bps to 50bps above the policy rate.

The recent amendments in the SBP Act mean that the government will become increasingly reliant on banks to borrow funds and this can reignite banks’ temptation to ask for abnormally higher returns on T-bills

While announcing the initiation of inquiry into banks’ behaviour in T-bills auction, the CCP has highlighted these two points through a press release. It has also highlighted a third point — that is, in some instances, primary dealers were found to have submitted identical/similar bids “and common bidding patterns were also followed by some of them.”

Regardless of the outcome of the CCP’s inquiry, a few things about banks’ behaviour must be kept in mind. Primary dealers and other banks and non-bank financial institutions participating in T-bills auctions price their bids for T-bills on the basis of their perception of the government’s urgency for bank borrowings. The SBP policy rate does not serve as the only indicator for them to measure this urgency. They also rely on the cut-off yield of T-bills in the last auction, the actual amount borrowed by the government in the last auction (close to the target, below or above the target) and secondary market yields of T-bills etc.

That is why when primary dealer banks foresee an inevitable monetary tightening coming, they start demanding higher returns on T-bills. And if the exact increase in the SBP policy rate falls short of their calculations, they start asking for abnormally higher returns on T-bills. They do so in anticipation of a further hike in SBP’s policy rate.

What is more perturbing, though, is that the cut-off yields on T-bills or the highest yields at which the bills are sold in the auctions remained abnormally higher even after SBP’s full dose of monetary tightening. The central bank announced an increase in its policy rate by 150bps on 21st November to 8.75 per cent and by another 100bps to 9.75pc on 14th December to tame inflation. However, the cut-off yield on 3-month T-bills stood as high as 10.78pc in the auction held on 15th December — the day when the new policy rate became effective. This showed a gap of no less than 103bps between the new policy rate and the cut-off yield. In subsequent auctions, the gap gradually narrowed.

In the auction held on 26th January, a day after the CCP issued a press release about its initial inquiry into banks’ behaviour in T-bills auctions, the cut-off yield fell to 10.30pc — and the spread between the policy rate and the yield narrowed to just 30bps.

Even before the initiation of the CCP inquiry, SBP had internally pointed out to primary dealers that they were quoting abnormally expensive bids for T-bills — and later on, the Monetary Policy Committee (MPC) of the SBP even went public about it.

From September to December 2021, the average difference between the SBP’s policy rate and the cut-off yield for 3-month T-bills rose to 114 basis points instead of the usual 25bps to 50bps

In its 14th December press release issued to announce 100bps policy rate increase, the MPC said that since its last meeting (held on 19th November) “secondary market yields, benchmark rates and the cut-off rates in the government’s auctions (of treasury bills) have risen significantly. The MPC noted that this increase appeared unwarranted.”

News about the opening of the CCP inquiry — and SBP’s internal warnings to banks — have seemingly worked for the time being. In the 26th January auction of T-bills both the cut-off yields as well as the weighted average yields of 3-month, 6-month and 12-month T-bills have declined noticeably from the levels seen in the previous auction held on 12th January, SBP’s data updates show.

But future behaviour of banks cannot be guaranteed because the enactment of a new law through recent amendments in the SBP Act has closed the doors for the government to borrow from the central bank. This means the government will become increasingly reliant on banks to borrow funds for budgetary support. This can reignite banks’ temptation to ask for abnormally higher returns on T-bills.

But they can act out such temptation only if the central bank’s vigilance becomes weak or if the CCP lowers its guards. It is the job of the CCP to curb unfair market practices and probe suspected cartelisation in any industry. One would come to know whether banks had made a cartel for submitting unusually pricey bids for T-bills in some of the past auctions only after the completion of the inquiry. Let’s see!

Published in Dawn, The Business and Finance Weekly, January 7th, 2022