Central bank wants lending rates in Sri Lanka to fall 200bp

ECONOMYNEXT – Sri Lanka’s banks should lower the average lending rate by 200 basis points to avoid ceilings on lending rates Central Bank Govnor Indrajit Coomparasway said after price controls were controversially slapped on depositors.

"The prime lending rate has come down by 120 basis points but the average weighted lending rate hasn’t moved at all," he told reporters on Thursday.

"We anticipate a significant reduction up to 200 basis points in lending rates, and not just in prime lending rate, but we need to see the verage weighted lending rate (AWLR) come down, and over the next weeks we will monitor that very carefully," Coomaraswamy said.

Price Controls

Price controls on deposits were effective from May. At the most recent round of price controls announced July, three month deposit rates were cut by 171 basis points.

Sri Lanka’s bank prime lending rate, which is published weekly by the central bank had fallen to 11.13 percent by July 05, from 12.20 percent on May 03.

The last publicly available published average weighted lending rate was 14.48 percent for May 2019, up from 14.47 percent in April.

Coomaraswamy said it is understandable that lending rates are falling slowly, as the price controls are only applicable for new deposits and lending rates costs fall only when the deposits are rolled over.

About 75 percent of Sri Lankan bank funding comes from deposits, he said.

"Their cost of financing won’t come down till they start re-pricing their deposits," he said.

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"But it would be good if it was faster."

Coomaraswamy admitted that price controls are bad.

"We really don’t want to enforce a lending cap because those type of measures are highly distortionary, but if we are forced to do it, we will," he said.

"However, we anticipate banks will be co-operative. We have been speaking regularly with the bank chief executives and they also see that lending rates would fall in the coming weeks."

Wealth Transfer

The central bank slapped controls on deposit rates, controversially transferring wealth from depositors to shareholders and warned the same will be done to shareholders through lending rate caps unless loans were given at cheaper prices.

The wealth transfer by state intervention is seen as not fair by advocates who want a market-based economy to be re-established in Sri Lanka to benefit the poor as it had done in post communist states that ended controls.

Sticky free market deposit rates are a hedge against currency collapses.

However when bad loans rise after monetary instability, depositors may help themselves by boosting capital buffers of banks, analysts say.

Bad loans at banks have spiked after the monetary instability generated by the central bank during 2018.

Instability was however worsened from October by President Maithripala Sirisena, who triggered a political crisis, further speeding up capital flight, which put the central bank in a difficult position forcing it to prolong a liquidity short in the banking system, analysts have said.

Dollar bond holders, whose transaction are not cleared through Sri Lanka’s monetary based also sold sending sovereign bond yields soaring.

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After the Federal Reserve generated the 2008 Great Recession and Bank Run with very low policy rates, western governments have advocated a tax on banks to help fund bailouts instead of putting the whole burden on the general taxpayer.

Deposit insurance also works on the principle of containing costs within the sector and not burdening third party tax payers. (Colombo/Jul12/2019)