Credit Management

Higher Spread
Introduction

 Interest spread, the difference between what a bank

earns on its assets and what it pays on its liabilities
 It has been on an upward trend during the last few
years
 An increase in the interest spread implies that either
the depositor or the borrower or both stand to loose
 If the increase in spread is due to lower return to
depositors then this discourages savings;
alternatively if it is due to higher charge on loans,
investment decisions are affected
Determinants of interest
spread
 Market structure of the industry
 Bank specific factors
 Macroeconomic variables
 Financial regulations.
Methodology

yit = aO + bXit + eit …

Where yit= interest spread
(aO,b)= vectors of parameter
eit= stochastic error term
Xit = vector of explanatory variables
CASE STUDY!!!
About ALLIED BANK

 It started out in Lahore by the name Australasia

Bank before independence in 1942
 It was renamed Allied Bank of Pakistan Limited
in 1974 and then Allied Bank Limited in 2005
 It offers universal banking services, while
placing major emphasis on retail banking
 Largest network of over 700 online branches in
Pakistan
Likely causes of high spread
in ABL:
These are the following reasons for high IRS:
 lack of adequate competition
 scale diseconomies due to small size of
markets,
 high fixed and operating costs
 high transportation costs of funds due to
expensive telecommunications
 existence of regulatory controls
 perceived market risks
 These factors lead to high intermediation costs,
which result in high spread
 Small borrowers with no property rights have no
collateral to offer. As such, they are perceived as high
risk borrowers
 The latter encompasses maintenance of law and
order and provision of basic transport and social
infrastructure, all impinging on security, a lack of
which has been found to be a cause for high
transaction costs resulting in large intermediation
costs
 Particularly in ABL, excess liquidity, reflecting poor
investment climate and scarcity of bankable projects,
has been identified to be responsible for high IRS
 In the absence of any secondary market for
government bonds and other securities, the public is
left with no option but to keep their savings as bank
deposits. Because of surplus funds, deposit
mobilization does not require any serious effort on
the part of the bank. Consequently, deposit interest
rates have remained low. Customers denied with
their real right.
Factors adding to Spread

There are five basic sources which widen the

interest spread in ABL. These are:
 Administrative Cost
 Loan Loss Provisioning
 Tax Payments
 after Tax Profit Margin
Administrative cost 

 This comprises wages and salaries and housekeeping

costs, besides the newly emerging costs due to
introduction of innovations. The latter involves
computerization, installation of ATM machines and
debit card facilities and their annual operation. In
fact, one of the offshoots of innovations is the rise in
wage cost. ABL is now employing more qualified and
skilled persons. Although computerization has
enabled retrenchment of clerical staff, higher salaries
for technically qualified persons have given rise to
higher wage bills.
Tax payments

 Direct taxes, being the dominant item in this

category, affect the spread positively. If
taxation is imposed on accrued basis as
opposed to actually received interest, it will
be higher, as it overstates taxable profits and
understates the level of taxation.
Accounting tax profit margin

 This term refers to after tax profit, which is

arrived at after netting out operating costs
including administrative costs, interest paid
out on deposits, additional loan provisioning
amounts provided each year and tax
payments, from total income derived which
includes interest income as well as non
interest income. This would also depend upon
how accounts are drawn and finalized.
Loan loss provisioning

  Adequate level of loan loss provisioning is

considered necessary, since current
recessionary conditions have been resulting
in an increase in non-performing loans in
ABL.
Competition

 Lack of competition in the banking sector

allows banks to maintain high spreads and
extract above normal profits.
 Customers have to pay this in the form of
high interest spread to ABL and every bank.
Macroeconomic Factors

 Real GDP growth generally affects the

banking spread by influencing the credit risk
factor
 The liquidity position of the banking sector
and monetary policy changes affect the
variability of interest rates
 interest rate volatility increases during the
transition periods and positively affects the
banking spread
Deposits Structure

 In general, the deposit structure of the Allied Bank is considered

to be an important determinant of banking spread. Allied Bank
has the discretion to revise the indicative rates on PLS deposits
disclosed at the time of accepting the deposit. The distribution
of deposits by types of accounts also provides useful
information in understanding the deposit structure of the bank.
Research indicates that the share of fixed deposits in total
deposits was around 25 percent at end-June 2006, and a large
portion of these fixed deposits fall in the category of less than
six months maturity. The greater share of short term deposits
also contribute towards low deposit rates as the return on these
deposits is lower than fixed deposits of longer maturity.
TREND ANALYSIS
2004 to 2008
DEC 31 2003 2004 2005 2006 2007 2008

Assets

Cash & 100% 110.0% 160.9% 220.8% 271.4% 229.8%

balances with
treasury &
other banks

Lending to 100.0% 105.3% 37.6% 124.0% 119.9% 102.8%

financial
institutions

Investments - 100.0% 140.7% 110.3% 115.3% 206.1% 202.9%

net

Advances - net 100.0% 146.3% 273.5% 354.2% 414.2% 523.8%

Operating 100.0% 98.3% 181.8% 248.3% 290.8% 428.9%

Fixed assets

Other assets 100.0% 101.6% 113.6% 155.2% 163.3% 264.4%

Total assets - 100.0% 131.8% 163.9% 214.5% 272.4% 312.0%

net of
provisions
Liabilities
Customer 100.0% 110.7% 141.3% 180.4% 231.1% 260.4%
deposits

Inter bank 100.0% 470.5% 363.8% 690.9% 860.7% 1042.5%

borrowings

Bills payable 100.0% 143.0% 138.1% 128.5% 197.1% 166.6%

Other liabilities 100.0% 113.1% 157.7% 180.6% 258.6% 480.5%

Sub-ordinated
loans
Total Liabilities 100.0% 119.1% 146.5% 192.9% 247.1% 283.4%

Share capital 100.0% 414.3% 422.2% 422.2% 506.6% 608.0%

Reserves 100.0% 2035.7% 1020.6% 1099.4% 1084.6% 1040.5%

Un - 100.0% -97.3% 42.1% 86.4% 107.4% 131.5%
appropriated
profit / (loss)

Equity - Tier I 100.0% 194.0% 265.2% 333.3% 378.1% 427.3%

Surplus on 100.0% 90.3% 182.8% 163.0% 164.3% 173.3%

revaluation of
assets

Total Equity 100.0% 258.0% 366.1% 445.0% 500.1% 562.5%

Interpretation

 High interest spread deals with Lending and

Deposits
 The trend of lending is not going to a right
side
2004 2005 2006 2007 2008

105.3% 37.6% 124.0% 119.9% 102.8%

These figures does not show a good condition

the trend of lending is changing every year in
ABL.
 Now the second thing in the affair of interest
rate spread is “Deposits”
2004 2005 2006 2007 2008

110.7% 141.3% 180.4% 231.1% 260.4%

These above figure shows the increasing trend

in deposits every year in ABL.
 Overall, the trend analysis shows the
exploitation of the customers in ABL. The
lending in ABL is declining year by year while
deposits are remain at reasonable figure.
conclusion

 The customers are really exploited by banks.

 ABL is also exploiting the customers by keeping a
major difference in interest rates of lending and
borrowings.
 Interest rate spread is like a lending indicator as
well.
 The increase in spread has an adverse bearing
upon the effectiveness of bank lending channel of
monetary policy and has therefore important
implications for the economy
Recommendations

 The reduction in the discount rate by the State Bank

of Pakistan is necessary. It might be led to the
decrease in banking spread by 17 percent or more
 Banks should review their interest rate policies at
collective terms
 Other areas of cost-cutting are through innovations
that will reduce the cost of delivery of bank’s
products. It is expected that gains from banking
efficiency and other financial system reforms will
reduce spreads
 Incomes derived by banks from other sources
decrease the spread. The non-interest income is
derived mainly through fees and charges levied
on loans and other transactions, and income
from foreign exchange businesses.
 ABL must explore the idea of infrastructure
sharing to improve efficiency and reduce cost of
operations
 Competition should be increased in the banking
sector
Thanks !!!