THE days preceding the October 17 announcement of market- stabilising emergency measures by the Governor of the State Bank of Pakistan reminded many of us of the scenes witnessed soon after May 28, 1998, but by responding boldly (though belatedly) to the challenges, the SBP has revived the market sentiment.

The two per cent immediate cut in Cash Reserve Requirement (CRR) and another one per cent effective November 15, and exemption of deposits with life spans of one year and above from the Statutory Reserve Requirement (SLR) helped all market players; with banks less restrained, they too heaved a sigh of relief.

Along with the one per cent relief given on October 11, the total CRR relief in October implied injection of Rs102 billion into the system. But during July-September, bank deposits fell by Rs232 billion and Rs54 billion worth of reserves freed by this fall had already flown into the system. The post-October 17 injection therefore added only Rs48 billion – too little at the start of the peak borrowing season.

But the relief in SLR has returned to banks over Rs125 billion of T-Bills for collateralising and borrowing there against. With these bills, banks, that couldn’t borrow from other banks on clean basis, can do so now. A more significant relief is the doubling of PIB’s share in the SLR. The bonds issued in 2004-05 were a burden; besides being loss-making investments, they were also ineligible for collateralisation.

Another important relief is the acceptance of the demand for converting short-term loans secured by shares into one-year term loans to help postpone sale of shares till their prices rise realistically. This will slowdown a slide in share prices (and in foreign portfolio investment) that is feared after removal of the lower lock on share prices, but could block scarce bank credit in these loans.

Together, these measures have lowered inter-bank lending rates significantly (down to four per cent), and prevented money-centred banks from benefiting for too long from the liquidity crisis. The overall effect has been the return of a semblance of stability, which has also strengthened the rupee in the inter-bank as well as the open market, and discouraged dollar hoarding.

In spite of all this, this scenario won’t last without long-term stabilising measures. To begin with, despite lowering the CRR and SLR (that could boost banks’ capacity to lend up to 75 per cent of their deposits), the SBP’s lowering of the loan-deposit ratio to 70 per cent implies contracting credit supply in a quarter known for high credit off-take triggered by cotton buying.

Second, according to the latest SBP statistics, in the next quarter, the State Bank will sell back to banks close to $2 billion under maturing swap deals. This will suck out from banks nearly Rs160 billion in counter-value. As it is, there isn’t enough liquidity in banks; unless bulk of the swaps is rolled-over, the twin effect of the credit hike for cotton buying and payment of counter-value of the swaps could again strain bank liquidity.

Cutting the CRR along with lowering loan-deposit ratio (by March 31, 2009) implies that fresh loans be funded by fresh deposits sucked out of the money in circulation. That’s prudent. Of the bank deposits withdrawn so far, over Rs142 billion went into money supply raising it to a whooping Rs1.14 trillion.

But with inflation eating into the capacity to save and mounting demands by trade and industry for lower lending rates, it would be hard for banks to offer attractive deposit rates and also cut lending rates. In this setting, banks can’t earn the high interest rate spreads that they got used to, tragically, at the expense of long-term economic interests.

Vacation of the stay granted by the SHC against the CCP action against banks on the charge of cartelisation manifests that banks were less than fair in compensating depositors as well as in pricing loans. During the past four years, it was repeatedly pointed out that bank profitability was eating into the cost efficiency of business and industry but to no avail.

Now banks must provide borrowers the life support of cheap credit. Banks don’t have a choice. It is their biggest challenge and obligation that remained on the backburner for too long. If they want to earn ‘fair’ profit during the coming recession, they must do so by helping their borrowers regain their competitive strength and, within banks, by increasing resource productivity, not interest rate spreads.

But indications are that they are now more concerned about safety of risk assets. That’s why on October 22, they invested another Rs60 billion in T-bills rather than lend to business and industry. Banks must realise that long-run survival of the economy is in everybody’s interest and all stakeholders must strive for a balanced (not skewed) sharing of the benefits.

Striking that balance, which we ignored under self-centred leadership in institutions, is now imperative. Not doing so could prove disastrous for all stakeholders because of a systemic failure triggered by large scale-failure of businesses. Reduced or expensive credit to business and industry to insulate banks from loan losses could lead to business closures.

Indications are that this trend is developing and external pressures may force a rise in mark-up rates. To prevent this tragedy from crystallising, banks must mobilise huge amounts of a wide variety of fresh domestic resources to bring down the overall cost of deposits instead of either reducing credit or making it expensive. This is what the SBP Governor hinted at in her October 17 press conference.

Both banks and the SBP overlooked for far too long the fact that, if stiffly regulated, support services like risk-rating, advisory, custodial, and asset valuation, can extend vital assistance to banks in containing credit risk. However, they remain weakly regulated instead of being properly licensed (separately for each business niche) by truly competent authorities and supervised very effectively. If businesses aren’t helped, the build-up of slow-moving loans will perk-up loss provisions and greatly dampen the pace of profit growth witnessed during 2004-07. This could hurt investment sentiment if banks were to rely on issuing stock dividends and right share issues to increase bank equity, year-after-year for the next four years, as envisaged by the SBP’s over-optimistic capital adequacy demands.

The merger of KASB Bank and Atlas Bank, and news about an investor group headed by Mr Hussain Lawai of the MCB fame acquiring (and logically thereafter merging) MyBank and Arif Habib Bank to create more viable banks out of synergy, is a positive development. There may be more mergers, but based on recent experience, the SBP must not lose sight of the hiccups the process involves.