The domestic banking sector making huge profits on wide interest rate margins (difference between lending and deposit rates) has increased its lending to the private sector by 27.8 percent, creating new loans amounting to Rs. 290 billion in 2010, latest data from the Central Bank showed. But coming from a low base, there is room for more credit growth without further fuelling inflation, already under severe stress.
Domestic banks total lending to the private sector as at end December 2010 reached Rs. 1,333.8 million, up 27.8 percent from a year earlier which was Rs. 1,043.8 billion. Foreign banking sources gave loans amounting to Rs. 10 billion, with total credit amounting to Rs.160.4 billion, up 6.6 percent from Rs. 150.4 billion a year ago.
Net credit to the government declined 2.1 percent during the year. Credit from the Central Bank declined 29.5 percent to Rs. 76.9 billion from Rs. 109 billion a year earlier. Credit from domestic banks increased 3.2 percent to Rs. 417.9 billion from Rs. 404.8 billion a year ago while credit from foreign banking sources amounted to Rs. 132.4 billion, up 4.7 percent from Rs. 126.5 billion.Domestic bank increased their lending to public corporations by 25.5 percent during the year, reaching Rs. 91.9 billion end December 2010 from Rs. 73.2 billion a year earlier. Foreign banks lent Rs. 49.6 billion during the year.
Although inflation pressures are mounting, due to external pressures as global food and commodity prices continue to increase exacerbated by the recent flooding, the Central Bank, and International Monetary Fund (IMF) are confident a policy response is not needed at this stage as Sri Lanka’s economy is not showing signs of overheating, unlike in other emerging economies.The countries banking sector also believes this and dealers told The Island Financial Review that interest rates should remain stable, while some suggested another policy rate was not unlikely. Policy rates at present are 7 percent for overnight commercial bank excess liquidity parked at the Central Bank and 8.5 percent for overnight borrowing from the Central Bank.
The high growth in credit to the private sector is not worrying the Central Bank, nor is it worrying the IMF. They believe this lending growth would not cause the economy to overheat (too much money chasing after too few goods) partly because it is derived from a low base, 2009 when credit to the private sector contracted.The Central Bank wants commercial banks to reduce their interest rate margins further this year so that the private sector would have access to affordable credit and thereby foster economic activity.
Central Bank Governor Ajith Nivard Cabraal earlier this year said the interest margin of the banking system was 4.5 percent.
"It will be possible to lower the margin to around 3.5 percent to 4 percent by end 2011, given the stability in interest rates," he said announcing the ‘Road Map: Monetary and Financial Policies for 2011 and Beyond’ at the Central Bank auditorium.
The Central Bank wants to keep inflation low, the obvious reason is to keep the cost of living down but also wants a low inflation rate regime to discourage short term capital inflows to the country.
However, banking sector analysts warn too much consumer lending could be dangerous. They also warn the government should not resort to printing money. Just before global food and fuel prices peaked in 2008, causing inflation to soar near 28.2 percent in June that year, the banking sector came under fire by the Central Bank for excessive lending. In January 2010, the Central Bank also said the government should not resort to reckless spending as it could put pressure on inflation and interest rates.
Related Info :
• Sri Lanka’s Inflation Rises. Central Bank Keeps Rates Steady in the Face of less Price Pressure despite Floods
The interest margin, cost of funds and overhead costs, are among the four factors used by banks in determining their lending rates, besides a credit's level of risk.
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