Bank lending rates seen rising 1.5-2.0%

In response to the Central Bank’s monetary policy decision to increase the Statutory Reserve Ratio (SRR) on commercial banks, Sri Lanka’s bank lending rates are seeing an increase of 150 to 200 basis points (bhp), banking sector analysts claim. 
Central Bank of Sri Lanka (CBSL) on December 30 increased the SRR by 1.5 percent to 7.5 percent effective from January 16, in a precursor to rein in the excessive private credit growth in the economy.
CBSL said the excess liquidity could fuel demand-driven inflation and create external vulnerabilities due to higher imports. 
Some of the banks have already raised their lending rates in response to the monetary policy decision as liquidity in the domestic market is seen fast drying up. 
Banking sector analysts say the increase in lending rates could minimize some of the negative impacts from the Budget impacting the banking sector. 
The SRR requires a bank to set aside a certain amount of deposits (currently 6 percent) at the Central Bank with no return. This is besides the mandatory 20 percent that must be set aside at the Central Bank at the Standing Deposit Facility Rate (SDFR) of 6 percent. 
Another 2 percent of the deposits are also kept in the bank in liquid form. 
In effect, when a bank raises a deposit, it can advance only up to 72 percent of the deposit but now with the higher SRR, the amount it can advance falls to just above 70 percent. 
According to economists, the SRR is similar to a tax imposed on commercial banks as it forces the banks to keep their hard-mobilized deposits in idle form at the Central Bank without earning any interest.  
This drives up the cost of funds for the banks and to compensate it, the banks respond by increasing their interest rates on their loans to maintain their margins to remain profitable.
The SRR has many unintended consequences such as widening the gap between the deposits and lending rates – interest margin as banks do not increase the deposit rates as much as the lending rates, penalizing both the depositor and the borrower. This creates an inefficient banking system. 
According to the former Deputy Governor of the Central Bank Dr. W.A. Wijewardena, the SRR forces the banks to move away from core banking activities to fee-based banking.  Due to the rise in the SRR, an estimated Rs.50 - 100 billion is expected to dry up from the market, which otherwise could have been used by the banks for lending. 
Deposit rates have also been on the up since the beginning of fourth quarter of last year, probably with the expectation of tighter monetary conditions. Some banks are even offering between 8 – 8.5 percent for their 3-months fixed deposits to lure funds to fund their advances growth.  Sri Lanka’s treasury bill rates at all three maturities rose at this week’s primary auction with 1-year treasury bill rising to two year high of 7.42 percent at last Wednesday’s primary auction. 
Meanwhile, the interbank call money rate rose to a 3-month high of 6.55 percent on the same day. Sri Lanka’s net credit to the private sector in October 2015 increased to an all-time-high of 26.3 percent year-on-year or by Rs.158.3 billion, virtually doubling the previous all-time-high of Rs.87.6 billion in 
September 2015.  
 However, many economists are of the view that the Central Bank’s move is a ‘too short-too late’ as in a similar move in April 2011, the 1 percent hike in SRR did not bring about the desired results, pushing the Central Bank to raise policy rates to tighten 
the monetary policy.