Deposit Pricing After a 250 Basis Point Hike
The central bank raises the policy rate by 250 basis points to 19.5%. Inflation is 24% year on year and GDP growth has slowed to 1.7%. Your bank's balance sheet: earning assets of PKR 55 billion, of which PKR 30 billion is KIBOR-linked corporate lending repricing quarterly and PKR 25 billion is fixed-rate - PKR 20 billion corporate at 13% with more than two years to run, and PKR 5 billion consumer at 14%. On the funding side: PKR 30 billion current accounts at no cost, PKR 10 billion savings at 8%, and PKR 25 billion term deposits at 14%, of which 70% is expected to reprice within twelve months. Two competitors have already moved savings rates to 16-17%. Your treasurer argues for holding savings at 8% to protect margin; the business head warns of deposit flight, since 40% of savings balances exceed PKR 1 million. ALCO meets on Monday and wants a deposit pricing position with numbers.
1. Compute the twelve-month net interest income effect of three savings-pricing options and express each as a change in net interest margin on the PKR 55 billion asset base.
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Asset effect. Only the PKR 30 billion KIBOR-linked book reprices in the window: 30,000m x 2.5% = +PKR 750 million. The PKR 25 billion fixed book contributes nothing for more than two years.
Term deposit effect (same under all options): 25,000m x 70% x 2.5% = PKR 437.5 million of extra cost.
Option A - hold savings at 8%. Change in NII = 750 - 437.5 = +PKR 312.5m. NIM effect = 312.5 / 55,000 = +0.57 percentage points.
Option B - match competitors at 16% on all savings. Savings cost = 10,000m x 8 points = PKR 800m. Change in NII = 750 - 437.5 - 800 = -PKR 487.5m. NIM effect = -0.89 points.
Option C - tiered: 16.5% only on savings balances of PKR 1m and above (about PKR 4 billion of the PKR 10 billion). Cost = 4,000m x 8.5 points = PKR 340m. Change in NII = 750 - 437.5 - 340 = -PKR 27.5m. NIM effect = -0.05 points, i.e. broadly margin-neutral.
So the treasurer is right about the arithmetic and wrong about the decision: option A wins on the spreadsheet only if the deposits stay.
2. Recommend a position to ALCO, justifying it with deposit elasticity, real interest rates and the fixed-rate asset book.
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Recommend option C, with a defined trigger to move to B for a segment.
- Elasticity. Option A assumes zero deposit elasticity, which is wrong for the segment that matters. Balances above PKR 1 million are held by businesses and high-net-worth individuals who compare rates weekly; an 8-point gap to competitors is far outside any plausible switching cost. If even 20% of the PKR 10 billion leaves, the bank must replace PKR 2 billion with term money at roughly 16.5% - about PKR 170 million a year more expensive than the tiered cost, before counting lost transaction and fee income from the same customers.
- Real rates. With inflation at 24% and a policy rate of 19.5%, the real policy rate is about -4.5%. The central bank is likely still tightening, so this 2.5-point repricing of term deposits is not the last one. Funding a fixed 13% corporate book with money that reprices upward is the real risk, not this year's NIM.
- The package. Tiered savings rate; a three-month term product at 17% for balances above PKR 2.5 million, to convert hot money into dated money; and non-price retention - relationship contact, free remittances, faster LC turnaround - for the sub-PKR 1 million segment, where elasticity genuinely is lower.
Trigger: if net CASA outflow exceeds 5% of the base in any fortnight, move the whole savings book to the competitor rate and accept the margin hit. A bank with a funding gap has no margin worth protecting. Also cap new fixed-rate corporate lending at 13% until the cycle turns.
3. State the twelve-month repricing gap under options A and C, explain what it implies, and identify what the gap measure misses.
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Gap. Rate-sensitive assets repricing within twelve months = PKR 30 billion. Rate-sensitive liabilities = PKR 17.5 billion of term deposits plus whichever savings repricing is assumed.
- Option A: 30 - 17.5 = +PKR 12.5 billion.
- Option C: 30 - 17.5 - 4 = +PKR 8.5 billion.
Implication. The bank is asset-sensitive. A further 200bp rise adds roughly PKR 250 million to NII under A and PKR 170 million under C, before any deposit outflow - but the same position bleeds if the central bank reverses, which makes a positive gap an explicit bet that tightening continues. Given a -4.5% real policy rate, that bet is defensible for now, but it must be a decision, not a residue.
What the gap misses:
- The PKR 20 billion corporate book at 13% is increasingly funded by 16-17% money, so its marginal spread is negative even though its accounting spread still looks positive.
- The 60% of term deposits that do not reprice in the window are treated as rate-insensitive on a contractual basis; behaviourally they are not, so the behavioural gap is smaller and the one-year earnings number overstates the protection.
- It says nothing about economic value of equity. A 200bp shock hits the PV of the long fixed book harder than the twelve-month NII figure shows, so ALCO should see the contractual gap, the behavioural gap and the EVE sensitivity together.