EDITORIAL: With a steep fall in interest rates, the saver is at a disadvantage in Pakistan. National savings rate in terms of GDP is less than half of that in regional economies, mainly due to low penetration level of banking services. Another reason for low savings is the lack of avenues for savings, particularly for those who opt for Islamic mode of savings. In the last decade, Islamic banking deposits have grown at twice the pace of conventional banking deposits. Deposits under this mode increased from 5.5 percent of total deposits in Dec 2011 to 10.2 percent in March 2020. But the return on deposits in Islamic banking is less than that of conventional banking. Had this not been the case, growth in Islamic banking deposits would have been much higher.
There are three types of deposits offered by banks - current, savings and time deposits. In March 2020, 37 percent of bank deposits were in saving accounts that yielded a return to the depositors in line with prevalent discount rate. The depositors of Islamic banks are largely deprived from potential returns in this segment. There is no return on current or checking accounts in any form of Islamic banking while on fixed deposits the Islamic mode offers returns in line with its conventional counterpart.
During mid-2000s, conventional banks offered low returns on saving deposits (commonly known as Profit and Loss Sharing - PLS accounts). In 2008, the State Bank of Pakistan (SBP) introduced a minimum rate of 5 percent on saving deposits for conventional banks. At that time, Kibor was hovering around 13-14 percent and the banks were not even offering 5 percent return to depositors. That is why SBP came up with this regulation. In 2009, SBP increased the minimum deposit rate (MDR) to 6 percent. By 2013, MDR was linked to the interest rate corridor and was kept at 50 basis points (bps) below the floor rate. In 2019, when policy rate was 13.25 percent, MDR was 11.75 percent. In March 2020, the corridor was made symmetric and the difference between policy rate and minimum deposit rate was reduced from 200 bps to 150 bps. Currently, the minimum deposit rate is at 5.5 percent based on 7 percent policy rate.
This has pared the margin for conventional banks; but depositors are being protected. However, no minimum deposit rate limit exists for Islamic banks. For example, in 2019 when conventional banks were giving returns of 11.25 percent on saving deposits, most of Islamic banks were not even offering a profit rate of 5 percent. Depositors in the Islamic mode have clearly been at a disadvantage. The traditional explanation offered for lack of any binding rates for Islamic banks is that they operate on profit and loss sharing basis. Moreover, the central bank too does not push Islamic banks to offer competitive returns to depositors because they lack asset avenues to invest. Conventional banks have loads of marketable securities and government bonds to park their excess liquidity. On the other hand, Ijara Sukuk for Islamic banks is in short supply. In addition, the return on these are at a discount (due to demand-supply gap) to equivalent tenor government bonds or securities.
Back in 2018, when deposits base was growing at a rapid pace, one Islamic bank stopped taking fresh deposits. That bank's credit policy prohibited issuance of fresh loans while there was dearth of Islamic assets in risk-free or low risk class. Hence, deposits were not entertained as the bank was unable to find assets to deploy against incremental liabilities. Furthermore, very few Islamic banks including Islamic operation windows in conventional banks, offer measly rates to depositors. As the rates vary from bank to bank, this often goes unnoticed by depositors. Bigger costumers do negotiate better rates; but a small ticker saver has little choice but to accept the standard rates offered by these banks.
The central bank needs to take notice of persistently low returns on deposits by Islamic Banks. It must come up with some form of a mechanism to ensure that small depositors in Islamic mode of banking should not be at a disadvantage. The question is why can't returns on Islamic deposits not be implicitly linked to the policy rate? The standard practice is that loans in Islamic banks are somehow (unstated rule) linked to the Kibor, then why can't deposits be accorded the same implied privilege?
Copyright Business Recorder, 2020
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