Banking likely to fall further as lending dries up

Continuing its gradual downward journey banking spreads slid to 7.32 percent in August - down 46 basis points from its peak of 7.78 in January 2009 - and are expected to reach around 7 percent by the end of 2009. Interestingly, in August, average fresh lending rate kept on declining (39 bps to 13.62 %) while deposit returns remained sticky with only 3 bps fall to 7.38 percent.
However, contrary to the general trend, 6-month Kibor is moving in the opposite direction - it increased, on average, by 22 bps to 12.27 percent in August compared with a decline of 113 bps in July. This shows the tight liquidity situation in the system; more importantly, there is virtually no money to offer to private sector after filling the appetite for government borrowing. The stiff competition on funds mobilisation, has kept the return on deposits rather sticky.
Although, latest data hasn been released yet, its safe to assume that this trend would have followed in September, as the liquidity problem amid budgetary support borrowing persisted last month. At this juncture, the revival of foreign flows, whether in the form of aid, loan or investment, to plug in government deficit or directly to private sector is necessary to enable banks divert the credit flows to private sector and lending rates to move in tandem with Kibor.
And given that chances of these foreign inflows are low in the immediate future, Kibor might hover around 12-12.5 percent with lending rates likely to remain sticky or continue slowly on its downward trajectory. This argument is strengthened with the reluctance of private sector to borrow at high rates.
The cautious monetary stance owing to fear of cost push inflation and enabling the government to attract commercial bank borrowing at decent rates, will not allow the deposits rate to move in southward direction. Now, this argument may not fit in with the general theory and past trends ie lending rates to increase in tight liquidity in the system, but the net retirement of credit calls for unorthodox analysis.