Monetary policy has been in the headlines again, amid reports the chairman of the Bank of Thailand has challenged one of the central bank's long-held tenets. Virabongsa Ramangkura has questioned the effectiveness of inflation targeting, whereby the central bank sets policy rates to influence economy-wide interest rates and ultimately ensure price stability and sustainable economic growth.
Undoubtedly, changes in the policy rate do affect the banking industry, but this is far from the goal of monetary policy. Monetary policy, after all, is meant to affect the real economy, which in layman's term means production, consumption, investment and exports. The banking industry itself, unfortunately, is not included as a part of the real economy.
The casual observer may wonder whether the policy rate is relevant at all to real people. After all, the Bank of Thailand has kept its benchmark one-day repurchase rate unchanged at 3% all year, and yet savers seem to be enjoying increasingly attractive deposit rates. These rising "promotional" rates _ some exceeding 4% annually for 24-month terms _ can be overlooked if we focus only on the "announced" rates of typical deposits such as savings or 12-month time deposits, which have remained relatively stable.
Since the announced rates do not reflect saving and borrowing costs, we have constructed a table of effective interest rates or "true rates" that measure representative deposit returns and average borrowing costs from five major commercial banks. These are calculated from the respective banks' balance sheets.
The results are illuminating. At the very least, they confirm our argument that the effective deposit rate has been on the rise this year. They also reveal that borrowers have been facing higher rates as well, in stark contrast to the policy rate's non-movement so far. This has led to hefty criticisms from the public that bankers are not adjusting their interest rates in a way that fully supports the stance of the Bank of Thailand. Let's look at some of the complaints and at what the data have to say.
Myth 1: On an interest rate uptrend, banks adjust lending rates more than deposit rates to widen their profit margins. Let's turn now to effective lending and deposit rates.
Using data from 2005 onward, we find when rates are on an upward trend, lending rates were adjusted only slightly more than deposit rates. Each upward adjustment of the effective lending rate averaged 21 basis points (bps) and each rise in the deposit rate averages 20 bps. The total cumulative increases in lending and deposit rates were 339 and 327 bps, respectively. So indeed, lending rates outpaced deposit rates but by a very slim margin. Much of of the gap was concentrated in the early periods of inflationary 2005 to the end of 2006, where lending rates outpaced deposit rates by almost 10 bps cumulatively. Afterward, however, the cumulative margin was razor-thin at merely 2 bps.
But profit opportunities for bankers are not present only in an interest rate up cycle. A down cycle can also be attractive if lending rates falls less than deposit rates. That's where we're heading next.
Myth 2: Lending rates fall less than deposit rates during a down cycle for interest rates. In this regard, we do see a stark contrast: banks do indeed decrease deposit rates more than lending rates. The evidence is quite conclusive. Average cuts in the average lending and deposit rates are 18 and 20 bps, respectively. Over the whole sample period, the lending rate fell by 236 bps compared with a fall of 256 bps in the deposit rate. So if one wishes to look at where bigger interest margins are being made, it seems the market has it all backward. It's the interest rate downtrend, not the uptrend, that switches on profit-maximising mode of banks.
Timing also matters here. The number of days it takes for commercial banks to respond to the decision of the Monetary Policy Committee (MPC) also gives us a clue to the potency of monetary policy. Our analysis shows that banks sometimes take preemptive action prior to the MPC decision. Deposit rates tended to move on average 5.8 days in advance of an upward policy rate announcement, while lending rate adjustments were about five days in advance. Pre-emptive downward adjustments, however, are rare. That explains why the upward trend usually produces a more upbeat tone from bankers and the market.
Once announced, it may take almost one month for lending rates to adjust to an increase in the policy rate, while deposit rates take at most two weeks. For both directions of policy rate announcement, it seems lending rates on average will take longer to adjust compared with deposit rates.
Myth 3: Commercial banks typically enjoy fat margins from lending out money and taking in deposits. This is often justified by casual comparison between the minimum lending rate (MLR) and the 12-month time deposit rate, which yield about a 5% spread.
In reality, the margins banks receive are way less than this rate. The effective spread, calculated from our effective lending and deposit rates, points to only about 2.5%, half the size of the widely perceived margin. The truth is banks often charge corporate clients at a rate much lower than the MLR _ hence, the MLR is not a de facto minimum lending rate.
On the other hand, banks pay more for promotional deposits than for regular deposits that are subject to the announced rates. And as a matter of fact, the size of these promotional deposits can be substantial on banks' balance sheets _ close to one-third of total deposits in some instances.
So in the end, do changes in the policy rate meaningfully affect lending and deposit rates? Our little investigation has shown that, indeed, domestic interest rates move with the policy rate but to a different degree and timing. In a bank-based economy such as Thailand's, if lending and deposit rates do not move with the policy rate, there will be little impact from a change in the policy rate on borrowers and savers and hence the real economy. Interest rates, then, are supposedly more obedient than previously thought.
TMB Analytics is the economic analysis unit of TMB Bank. Behind the Numbers is co-authored by Benjarong Suwankiri, the head of TMB Analytics, and Naris Sathapholdeja, the head of market risk modelling. They can be reached at tmbanalytics@tmbbank.com
